In 1983, a number of computer software companies reported use of an accounting procedure that was investigated by the SEC. The accounting policy is to capitalize the cost of developing computer software and amortize it over the life of the software (usually three to five years). This procedure is used by large and small companies, but the impact is more pronounced on smaller, new companies, in which a greater portion of their activity is devoted to software development.
An official of Comserv, a small company that specializes in software, said that small companies would be in deep trouble because of SFAS No. 86. He said smaller companies would be under strong pressure to keep costs down if development costs had to be expensed. He also said, relative to the immediate write-off of these costs that smaller companies would not be able to put as much cash into their own growth and development because of SFAS No. 86.
The SEC’s concern was whether this accounting policy was consistent with SFAS No. 2 concerning the expensing of research and development costs as incurred. In 1985, SFAS No. 86 treated software-related research and development costs the same as in SFAS No. 2.
Required:
a. Evaluate the software capitalization argument with reference to SFAS No. 2.
b. Why is the choice of accounting policies (expensing vs. capitalization) more likely to affect smaller companies?
c. Comment on the claim that small companies “wouldn’t be able to invest as much cash in their own growth if they couldn’t use [capitalization].” Is this a real economic consequence?
d. If you were a FASB member, how would you have voted on this issue?