How Restaurants Can Capitalize Internal-Use Software

Today’s restaurants are increasingly integrating technology into their everyday processes to meet the industry’s evolving standards. Internal-use software plays a particularly important role in determining a restaurant’s success, as this type of software may include internally developed inventory management software, customer data congregation systems, or restaurant-specific accounts payable automation.
 
These crucial investments, however, do not come free. In terms of accounting, how are restaurants allowed to capitalize the costs for internal-use software?
 
Defined in a 2015 regulatory overhaul, internal-use software refers to software that is developed by a taxpayer for use specifically in general or administrative functions. These functions encompass financial management, human resource management, and support services. The 2015 regulations specify that internal-use software is not to be sold, leased, licensed, or marketed to a third-party.
 
For restaurants that create their own internal-use software, incurred costs are divided into the research phase and the development phase. Luckily, restaurants can expense all costs incurred during the research phase of an internal-use software project. However, during the development phase, restaurants can only expense the following costs:
 
  • External direct costs of material and services consumed in developing or obtaining internal-use software
  • Payroll and related costs for employees who devote time to and are directly associated with the project
  • Interest costs incurred while developing internal-use software
  • Costs of enhancements or system upgrades.
 
Expenses that should NOT be capitalized include:
 
  • General, administration, and overhead costs
  • Inefficiencies or operating losses incurred during software implementation
  • Training and systems maintenance costs, updates, and minor modifications
  • Fees paid to outsiders for general systems consulting and overall control reviews
 
For GAAP purposes, amortization should be recorded over the software’s estimated useful life when the computer software is ready for its intended use. This should be done regardless of whether the software will be placed in service in planned stages that may extend beyond a reporting period. Because technology can be quickly outdated, a shorter life should be expected for the software, often between 3 to 10 years.

For tax purposes, internally developed software may be deducted in three ways:
 
  • Consistently treated as current expenses and deducted in full
  • Consistently treated as capital expenses and amortized over 60 months from the completion date of the software development
  • Consistently treated as capital expenses and amortized over 36 months from the date the software is placed in service
 
For a company that utilizes a third-party software for their general ledger, the cost of the software would be capitalized along with the costs of any future upgrades. Any significant payroll costs incurred to implement this software could also be capitalized.

For a company that has taken on the task of developing their own software, all costs of materials or services, payroll incurred to create/implement the software, and interest costs associated with implied debt servicing would be capitalized as software in progress. Once the software is ready to be implemented throughout the organization and placed in service, the software various costs will begin to be amortized over the expected life.
 
This article provides updates to a previous post on the Selections Blog: Capitalizing Internal-Use Software.
 
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