 Hello, and welcome to the session in which you would look at accounting for software costs. Specifically, we're going to be looking for software costs that deal with software to be sold, leased, or licensed to external parties, because we will have a separate recording for internal parties. Actually, it will be part of this recording toward the end. So how do we account for computer software costs? Well, initially, when the company start to develop a software, they're going to have to incur some costs, initial activities on software development costs. And that will include cost of planning, designing, testing, the software, up to a point where they feel that the software is workable. The software might have reached something called technological feasibility. Up to that point, all the costs that the company incur is expensed immediately, just like R&D. If you know what R&D is, research and development, we are going to expense those costs similar to R&D. So once we have reached technological feasibility, we established technological feasibility, so there is a life, there is a potential life for this software, what's going to happen? We're going to be incurring additional costs, such as coding, testing, debugging the software, manual preparation, up to obtaining a master copy. Basically, we have some sort of a prototype software ready to go. At this point, once we have reached technological feasibility, we are going to capitalize any cost as computer software costs. So this is what it's going to look like on a timeline. On a timeline, we're going to expense anything that happened prior to reaching technological feasibility. So once we have reached this technological feasibility, and usually it will be given to you on the problem, like you have reached technological feasibility, then what's going to happen is the cost between expense and technological feasibility obviously is expensed. Once you have reached technological feasibility, you are going to have what's called a computer software cost, computer software, some sort of an intangible. Now what's going to happen is you have an asset. Then after you have reached technological feasibility, at some point, you are going to start to sell. You're going to have starting your sale. Then what's going to happen to this technological feasibility? And let's assume we already accounted for $10 million as software costs, because we have reached technological feasibility. What are we going to do with this asset? I call it asset one. We're going to amortize using the greater of revenue method or the straight line method. I will come back and show you what's going to happen with this $10 million. Then once we have reached technological feasibility, now we are going to produce, because that's the reason why we did all this work, to produce the software, pack it, sell it, upload it on the cloud, let users buy it. It doesn't matter, basically sell it. Once we are selling the product, we're going to have another account called inventory. Now we have the software itself. The software is another asset. So notice we have inventory, the asset itself, and we have computer software cost, which is an intangible asset. Then we are going to start to sell the product. As long as we're selling the product, we're going to turn inventory into cost of goods sold. So inventory will eventually get expensed. Then we are going to be incurring customer support, maintenance cost, training, so on and so forth. Those we will expense. Now the only thing I did not talk about is what do we do with this $10 million when we reach technological feasibility and we put that as an intangible asset as computer software cost. Now this topic is covered in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. I don't replace your accounting course. I'm going to be a useful addition, use supplemental tool to your accounting preparation. In other words, I can help you improve your performance on the exam. I can help you understand the material better by explaining the material differently than your CPA review course, differently than your college courses. Your risk is one month of subscription. Give it a try. You like it. You keep it. It's going to help you. If not, you cancel. That's your risk. Your potential return is doing better. If not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. Here's a list of all my accounting courses that I offer on my website, including additional lectures, including multiple choice through false exercises that's going to help you do better. My CPA modules are aligned with your Roger, Wiley, Gleam and Backer. This way you can go back and forth between my material and your CPA review course. They're set up the same way. I also give you access to almost 1500 plus AICPA previously released questions that appeared on the CPA exam. If you haven't connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So what are we going to do with this $10 million that's considered software cost? Well, we're going to amortize it using the greater of two method, either the revenue method or the straight line method. How does the straight line method work? We should all be familiar with this. If we have 10 million, we're going to assume the software has a life of five years. So we're going to amortize 2 million per year. This is the straight line method. The revenue method, what's going to happen is we're going to estimate what's the total revenue for this software. Let's assume it's $100 million. Then for year one, we sold 25 million. Now the ratio is 25%. What we're going to do, we're going to take the 25% times the 10 million. And for year one, we're going to amortize 2.5. So we're going to amortize the greater of the straight line or the revenue method. So let's summarize computer software costs. We're going to expense all costs incurred to reach technological feasibility, basically treat like research and development costs. Then we're going to capitalize subsequent costs to reaching technological feasibility as intangible asset. How are we going to amortize it? Well, we're going to amortize this cost when the product starts to sell using the greater of the revenue method or the straight line method. So simply put on the balance sheet, we will have an amortized software cost. On the income statement, we're going to have amortization expense of computer software costs and R&D associated with the computer software development. Now everything that we talked about here is for software for external use. What happened when we have software that we are creating for internal use? Well, it's a little bit different. How so? We're going to capitalize as soon as we reach technological feasibility and we're going to start to amortize using the straight line method. Well, think about it. We cannot use the revenue method because we have no revenue. And since we are using the software for internal use, you don't have to wait until you start to sell it to amortize it. We're going to start to amortize as soon as we reach technological feasibility. Now what happens sometime is the company might create a software internally, then they might find out there's some some sort of a demand for the software. Then what's going to happen is they're going to start to sell the software to external parties. What's going to happen? How are we going to deal with this type of situation? Well, under those circumstances, we're going to be using a cost recovery system. How does it work? Well, simply put, when we start to sell the software initially, we are going to sell the software and we're going to recover our cost. So simply put, when we start to sell, we're going to start to remove the software to recover the cost. Once we have recovered the cost, then we'll start to treat any additional sales as revenue. So let's take a look at a quick example. Let's assume the book value of the software is 7 million. So this is how much it cost us. It's on the asset, on the books as an asset of 7 million. Well, when we sell the first 3 million, we're going to debit cash 3 million, credit the asset, some sort of an intangible asset, whatever we call that software. It's not revenue yet for 3 million. So notice initial cost was 3. Now we recover, initial cost was 7. We recovered 3. We still have to recover 4 million. Then what's going to happen? We're going to keep this entry until we have recovered the 7 million. Once we have recovered the 7 million and we are making sales, we're going to debit cash. Now we can credit revenue at this point. So when do we credit revenue? After we have recovered our cost, which is 7 million. So recognize revenue after we recovered 7 million. The best way to learn more about this topic is to go to my website farhatlectures.com, work additional multiple choice questions, see additional exercises. At the end of this recording, I'm going to remind you again to take a look at my website farhatlectures.com. You need to pass your CPA exam once. You don't need to do it several times. Invest wisely. Put the time. Don't shortchange yourself. The CPA exam is worth it. Once you are done with it, you can focus on your career. My subscription is minimal. And again, I don't replace your CPA review course. You keep your CPA review course. My resources work along your CPA review course. 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