Question

Garrett Corporation began operations in 2021. To maintain its accounting records, Garrett entered into a two-year agreement with Accurite Company. The agreement specifies that Garrett will pay $60,000 to Accurite immediately, and in return, Accurite will make its accounting software accessible via the Internet to Garrett and maintain all infrastructure necessary to run the software and store records. At any time, Garrett Corporation can freely remove its records and run the software on its own hardware or that of another accounting services company. In addition to the cost of the agreement, Garrett incurred $10,000 early in the year devising a plan for its accounting software needs, $20,000 for customizing its own computers for integration with Accurite’s software, and $15,000 after the software was implemented to train its employees.

Determine the initial amount that Garrett should capitalize related to the software development costs.

Answer 1

Let us analyse all the costs provided in the question one by one

1. Cost incurred on devising plan for accounting software needs ($10,000) : The costs incurred before initiation of the software development project are classified as preliminary costs and all such costs are to be classified as expense as they are sunk cost / historic cost and are undertaken to decide whether the software is to be developed or not. Therefore, the cost of devising plan for accounting software needs will not qualify to be capitalized as software development cost.
2. Cost for entering two year agreement with Accurite ($60,000) : The amount paid to Accurite under the two year agreement is classified as application development cost. It is directly attributable to the development of the software. Therefore, the amount paid under contract will qualify to be capitalized as software development cost.
3. Cost incurred on customizing own computers ($20,000) : The cost of customizing own computers is an integral part of the implementation and on site testing of the software and such costs qualify to be capitalized as software development costs. Therefore, the cost incurred on customizing own computers to make them compatible with the software will be capitalized.
4. Cost incurred on employees training ($15,000) : The cost incurred on training of employees after the implementation of of the software is post implementation cost and all types of post implementation costs are charged to expenses. Therefore, cost of training employees will jot be capitalized as software development cost.

CONCLUSION :

Hence, the cost committed under the agreement with Accurite should be capitalized in the books of accounts. The initial amount that is to be capitalized as Software Development Costs is $80,000.