FASB Revises Internal-Use Software Cost Guidance

In under a minute

• On Sept. 18, 2025, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2025-06, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software.”
• The ASU overhauls the internal-use software cost capitalization model by eliminating stage-based rules and replacing them with a principles-based framework to be more aligned with modern software development practices. The ASU also clarifies which disclosure framework applies to capitalized software costs.
• ASU 2025-06 is effective for all entities for annual periods beginning after Dec. 15, 2027, including interim periods within those years. Early adoption is permitted. 

How does the new ASU change the capitalization threshold?

Under current guidance, an entity determines whether development costs for internal-use software are capitalized based on both the nature of the cost incurred (for example, training costs are always expensed) and the stage of development in which the cost was incurred. Eligible costs incurred during the application development stage are capitalized, whereas costs incurred during either the preliminary project stage or the postimplementation-operation stage (for example, ongoing maintenance) are expensed.

Many entities now use software development methods that are more incremental and iterative in nature (for example, agile development) than the more dated sequential (or waterfall) development methods. Consequently, stakeholders encouraged the FASB to modernize the existing accounting requirements to address challenges faced when applying the current stage-based approach. 

In response to stakeholder feedback, the FASB issued ASU 2025-06, which eliminates the stage-based model entirely.

Under the new ASU, capitalization of costs to develop internal-use software begins when two conditions are met.

While the ASU removes the stage-based criterion from Accounting Standards Codification (ASC) 350-40-25-12, the remaining two capitalization criteria are largely unchanged. However, in response to stakeholder feedback, the board decided to add application guidance to help entities assess when the probable-to-complete threshold has been met.

Crowe observation: The removal of the stage-based approach more closely aligns with contemporary development practices, but it places increased importance on documenting internal judgments. Entities should consider updating existing processes, which should include contemporaneous documentation of project approvals, funding, and development road maps.

What additional application guidance was added to clarify the probable-to-complete threshold?

To clarify when the threshold for capitalization has been met, the ASU introduces the concept of “significant development uncertainty.” If such uncertainty is present, an entity may not capitalize costs until the significant development uncertainty is resolved. Under the ASU, indicators of significant development uncertainty are limited.

In the ASU, the FASB explains that the assessment of whether significant development uncertainty is present will be straightforward for some software projects, such as the implementation of a standard enterprise resource planning system. In contrast, for other software projects (for example, projects featuring heightened development risks), the assessment could be more complex.

Crowe observation: The language used in describing “significant development uncertainty” is similar to language used for the technological feasibility test used for external software development costs in ASC 985-20-25-2. In ASU 2025-06, the FASB explains that it “expects that capitalization of internal-use software costs generally will not change significantly for most types of software under the amendments in this Update. For the development of software to be provided via a cloud computing arrangement (CCA), the Board expects that the amendments could result in a decrease in software capitalization. This decrease in capitalization will better align with the accounting outcomes for the development of software sold via an on-premises license.”

Uncertainty arising from novel, unique, or unproven features or technological innovations may be removed only through coding and testing. As explained in the basis for conclusions, the FASB introduced this clarification “to improve the operability and the consistency of applying the amendments” and clarify “how to evaluate when significant development uncertainty is resolved.”

The ASU defines performance requirements as “what an entity needs the software to do (for example, functions or features).” In the basis for conclusions, the board explained that when assessing whether the significant performance requirements have been finalized, an entity does not need to have identified and ceased revising all the performance requirements. Instead, an entity should assess whether performance requirements that are significant have been identified or are expected to continue to be substantially revised.

How does the new ASU affect the accounting for website development costs?

Under the final ASU, Subtopic 350-50 is superseded, with website guidance merged into Subtopic 350-40. This aligns the costs incurred to develop websites with all other costs to develop internal-use software.

The impact of this change is expected to be limited, as the board noted most website development is already addressed under general software cost guidance.

How does the new ASU affect disclosure requirements?

The final ASU does not introduce new disclosure requirements, but it does provide much-needed clarification on the applicable disclosure framework.

• Internal-use software is explicitly excluded from the general intangible asset disclosure requirements in ASC 350-30.
• Internal-use software costs that are capitalized must be disclosed using the ASC 360-10 property, plant, and equipment (PP&E) framework, regardless of whether the asset is presented on the balance sheet as an intangible asset or otherwise.

This clarification addresses historical confusion and aligns with preparer practices for operational assets.

Crowe observation: Internal-use software must be disclosed consistent with PP&E – not intangibles – regardless of how it is classified on the balance sheet. Cross-functional coordination between accounting and financial reporting is critical.

When is the new ASU effective and what are the transition requirements?

The new ASU is effective for all entities for annual periods beginning after Dec. 15, 2027, including any interim periods within those fiscal years. Early adoption is permitted for any interim or annual financial statements not yet issued (or made available for issuance). If a company adopts the guidance in an interim period, it must apply the amendments as of the beginning of the annual reporting period that includes that interim period.

Crowe observation: The board considered whether to provide additional deferral for private companies but ultimately concluded that both public and private entities face similar challenges and operate in similarly dynamic software environments. As a result, a unified effective date was determined to be appropriate.

Entities may adopt the new ASU using a prospective, modified, or retrospective transition approach. An explanation of each approach and the effect on prior-period or current financial statements is provided in the following table.