A Bookkeeping Blueprint for Custom Software Investments

Deductions and considerations for custom apps

accounting for custom software

With custom applications and software platforms quickly becoming a norm in company investments and projects, a new area of accounting concern has followed suit. Investments in custom software development can be large relative to overall company expenses and even annual revenue. As an investment in the future, companies are recognizing the need to invest more and more capital and intellectual property into their custom software but often operate without a blueprint for how to properly account for these investments on their balance sheet and P&L.

Small and Self-Funded Businesses

Just like any other long-term capital expenditure, how you choose to account for your custom software will depend on your company’s unique needs and circumstances. To begin, the first question you will likely ask yourself is whether you need a deduction now or in the future. For small businesses or those that are entirely reliant on revenue-generated cash flow, you may be more likely to need a deduction in the current year to reduce your taxable income and keep more cash in your bank account.

Cash Flow Considerations

There is an endless array of reasons why you might need to improve your cash flow in a given calendar year. Perhaps you had additional expenditures in mind, have loan payments that must be made or need to create reserves for slow seasons. Maybe you want to bring on new staff or expand your physical location into additional facilities. All of these require cash outlay to get going—cash that you might be able to free up by categorizing an investment in custom software as a current period expense.

This will reduce your taxable income by your entire investment in the current calendar year.

The Case For Capital Expenditure Classification

Not all businesses will have the same cash flow considerations. If your business does not need the full deduction in the current period, booking the expense as a capital expenditure will allow the expense to be deducted over time.

For funded startups, there is often little need to take a full deduction in the current calendar year because they are not revenue generating. Apply a deduction against taxable income has no effect if a company does not have revenue. In fact, it could technically increase losses for a given calendar year. This is an acceptable course of action but doesn’t actually do anything to help your business. Taking excess deductions will create a net operating loss that can then be carried forward (or backwards) and used to reduced reduce taxable income. Meanwhile, taking the deduction over time could allow businesses to take a deduction in later years as a depreciation deduction.

Research & Development Credits

Research & development (“R&D”) credits are another important consideration in accounting for custom software investments. As custom software development often includes notable investments of time, money, and intellectual property to produce a final product, many of these projects may be eligible for R&D credits. Unlike tax deduction considerations, tax credits are amounts that directly reduce tax liabilities. In addition, they can be saved and applied in later years when they will have the most impact.

This is important for all businesses regardless of whether they are self-funded or funded by investment dollars. Any investment in custom software should be vetted for applicability of R&D credits.

The most important thing to remember is there is not a one-size-fits-all answer to how to properly account for custom software investments. In fact, accounting for multiple custom software applications within a single company may vary from one investment to the next. Your decision should be based on your current and future needs as well as the guidance and advice of a tax professional. However, don’t forget those R&D credits—they may come in handy!