Partner in Charge – Audit Department
A long overdue update to how companies accounting for internal-use software has been issued. On September 18, 2025, the FASB issued ASU 2025-06, titled Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software. This update marks a significant step in modernizing the accounting for software development costs in an era where cloud computing and agile development dominate the technology landscape.
Entities may apply the guidance prospectively or retrospectively, based on their preference. The ASU is effective for public business entities for fiscal years beginning after December 15, 2026, and for all other entities one year later, with early adoption permitted.
Some of the key changes in ASU 2025-06:
New Principles-Based Capitalization Model
The ASU replaces the rigid three-stage model (preliminary project stage, application development stage, and post-implementation stage) that required costly evaluation and recordkeeping with a principles-based model. Under the new model, costs are capitalized when they are directly attributable to software development and provide probable future economic benefits. In other words, you capitalize software costs when it is probably that the project will be completed and perform the intended function and not based on the stage of development.
Expanded Scope to Include Cloud-Based and Agile Development
The update clarifies that internal-use software includes both on-premise and cloud-based solutions, including software developed using agile methodologies. This change ensures that companies can apply consistent accounting regardless of the development approach or deployment model.
Enhanced Disclosures
For those companies preparing financial statements with disclosures, there are enhanced disclosures to provide the users of the financial statements better clarity on the policies and nature of software costs.
Simplified Guidance for Upgrades and Enhancements
The ASU simplifies the evaluation of whether upgrades and enhancements should be capitalized by focusing on whether the changes extend the functionality or useful life of the software, similar to the initial evaluation.
What This Means for You
Companies should begin evaluating their current software development accounting policies and consider how the new principles-based model may affect capitalization thresholds, project tracking, and financial reporting. Finance and IT teams will need to collaborate more closely to ensure proper documentation and support for capitalized costs. Companies should evaluate if they want to early adopt this new ASU and document their election in their accounting policy manuals. This new accounting policy does not change the accounting for external-use software – commonly known as Software as a Service and software to be sold or leased.
If you have any questions about this update, contact a WFY advisor here. You can sign-up for our newsletter here to receive more updates.
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