When developers talk, they talk about stories, sprints, and releases. At the same time, finance talks about costs, assets, and how money is spread out over time. This mismatch causes confusion when someone asks whether a project can be treated as an asset, how much the company is really spending on the product, or why burn looks high even though the work adds long-term value.
The fix to this conundrum is software capitalization: instead of charging every coding cost to this month’s budget, you record some costs as assets and spread them over several years. However, the rules for this process can be tricky, and the whole thing can feel like busywork rather than help.
This guide breaks down the meaning of software capitalization, which costs qualify, how to run the process, and how to keep engineers and finance on the same page without needing to turn developers into accountants.
Software capitalization is the practice of treating certain development costs as long-term assets rather than current expenses. To understand this, it’s important to know the difference between an expense and an asset:
Accounting frameworks (such as US GAAP and IFRS) allow this, but only under certain conditions. In simple terms, you need to show that:
This is where engineering matters; finance can’t judge those points on its own. They need the developers’ view on what’s being built, when, and by whom.
Most capitalization policies use a three-stage model.
This is the “Are we even going to build this?” phase.
Examples:
Even if this work leads directly to a successful product, it’s still treated as an expense. The project is too uncertain at this stage.
Once you commit to a specific product or feature set and start building it, you enter the development stage. This is where capitalization of software costs becomes possible.
Typical capitalizable items:
The key idea: These costs are for directly creating the software asset, not just exploring possibilities.
After launch, most work is no longer building a new asset. It’s maintaining or lightly enhancing the existing one.
Examples:
These are expensed, unless you spin up a new, clearly defined project (e.g., “New Billing Engine v2”) that itself qualifies as a capitalizable development project.
Even during development, some costs usually are not capitalized:
They might be essential for success, but they don’t meet the criteria for capitalization.
Let’s turn this into something you can actually run in a modern product and engineering organization.
Start with a short document (2–3 pages) that:
Engineers should be able to read this without needing a dictionary. If the policy is unreadable, it won’t be followed.
Capitalization happens per project, so you must know what’s inside the box.
For each capitalized project, document the:
This helps avoid the “everything in repo X is capitalized” problem. That’s a red flag for auditors.
Connect real engineering work to the accounting model using simple categories in your issue tracker:
Then agree with finance on which combinations are capitalizable in the development stage (e.g., implementation, testing, and project-specific docs) and which are always expensed (i.e., research and support).
You don’t need to tag every commit. Just make sure your categories are consistent and understandable.
You need a reasonable way to estimate the developer time spent on each capitalized project.
Common options:
Whichever you choose, keep it lightweight. People will not maintain a system that feels like a second job.
Once you know the effort split, convert it into actual money:
You don’t need perfect tags on day one. Start with rough but honest allocations, then refine. The important thing is that your method is consistent and defensible.
A monthly sync between engineering and finance avoids surprises.
Discuss:
This is also the right place to challenge borderline cases. If everything is capitalized, something’s wrong. If nothing is, you may be missing legitimate assets.
When a project goes live:
Engineering input is needed for:
You don’t need to manage the journals, but your roadmap and deprecation decisions affect the numbers.
You don’t need a new ERP system to start, but you do need a minimum set of building blocks, including:
If you already have regular engineering-finance check-ins, you can plug capitalization into those. If not, this is a good reason to start.
Why bother with all of this?
Capitalization is powerful, but it can backfire.
This can lead to audit findings and future restatements. If you’re ever unsure, it’s safer to expense.
Here, you’re losing legitimate value. Start with one or two obvious projects and grow from there.
The fix is not heavy bureaucracy; it’s small, predictable habits, such as a one-page project summary, a simple rules doc, and regular check-ins.
Costs qualify when they are directly tied to building a specific software product or feature in the development phase, not in research or routine maintenance. In practice, this usually means developer and contractor effort, plus project-specific environments and tools that create or significantly improve the software.
According to the GAAP and IFRS accounting standards, internally created software can be classified as an intangible asset as long as the project meets the conditions of there being feasibility, a potential intention to completion, likely benefits, and the costs to the project are measurable, once the software moves from a research to a developmental state.
Once the software is available for use, the capitalized cost is amortized over the determined useful life and is subject to impairment evaluations if usage decreases or the software becomes obsolete.
To support software cost capitalization, the software project should include a work tracker that provides an easy way to estimate or record effort to engineering and to access cost data for employees, contractors, and cloud tools. Other documents, such as project charters, architectural designs, and release records, can help explain what software was created, when it moved to a different stage, and the costs incurred at the time.
Overcapitalization can inflate asset values and short-term net income, thereby increasing the risk of audits and restatements. Undercapitalization can make periods of high spending look worse than they actually are and obscure how much money is really being lost on the products, which can confuse both internal and external stakeholders.
When the work is exploratory research, routine maintenance, minor improvements, support, or any other activity that doesn’t clearly create or significantly upgrade a separate software asset, the cost of the software should be written off. Suppose the project is highly uncertain or the team cannot reliably measure effort and link it to a defined development phase; in that case, expensing is usually the safer and more defensible choice.
Capitalizing software development costs is not just an accounting trick. It’s a structured way to connect what engineering builds with how the company reports value.
When you (1) define clear stages and policies, (2) draw reasonable project boundaries, (3) track effort in a lightweight way, and (4) review assumptions regularly with finance, you get financials that better reflect reality, without drowning your teams in process.
You still ship code. You still care about uptime, quality, and developer happiness. But now, when someone asks, “Can we capitalize this project?” you can answer with confidence, using a framework that both engineering and finance can stand behind.
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