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Capitalizing Software Development Expenses for SaaS Businesses

April 7, 2015

Just stop it. Maybe it made sense once upon a time with the perpetual licenses model when new software releases were every few years (although I doubt it), but it makes no sense for a SaaS company. Here is why:

  1. Development is ongoing and continuous. The software is never “done”, it is constantly evolving. As SaaS businesses update their code monthly/weekly/daily with all kinds of new functionality, even the concepts of “releases” and “modules” are becoming archaic.
  2. It makes the income statement and balance sheet a poorer representation of the financial realities of the business. Just ask the management teams: “We unwind capitalization for the reports we use to manage the business.”
  3. If the company wants to capitalize software development expense to become “EBITDA” positive for fundraising purposes, then they and the investors who bought into the fallacy deserve each other.

The good news is, this treatment is going away. However, there are still many accountants pushing less sophisticated SaaS businesses that direction.

If you are the CEO or CFO of a SaaS business, you should push back against any effort by your accountant to force you to capitalize any software development expenses.

We have seen the audited financial statement of hundreds of SaaS businesses, and software development expenses do not have to be capitalized to be GAAP compliant. It’s a judgment call, and good judgment requires you not to do it.

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