January 12, 1 998 Software Gains Capital Treatment A pending rule change will require accountants to treat software as an asset. Will this make it easier to get projects approved, or harder? By Justin Hibbard he accountants who keep the books of corporate America are going to change the way they look at your IT projects. Interested? You probably should be. Under a rule to be published this quarter, companies will be required starting Dec. 15 to treat software bought or developed for internal use as an asset on their balance sheets. Symbolically, this rule confirms what IS managers have known for some time and Wall Street has begun to recognize-that software can be as valuable as a factory or skyscraper. "Software is equivalent to the bricks and mortar of the in formation age," says James Harrington of Coopers & Lybrand, a member of the committee that wrote the rule. But the change will have more than symbolic impact. Because it deals with how software expenditures are recorded, the rule could make CEOs, chief financial officers, and business managers more willing to approve big IT projects because the financial pain will be spread over a number of years. At the same time, IS managers trying to get projects approved may have to jump through more hoops, such as predicting a planned system's life span and its return on investment. The bottom line is [the new rule] will probably make us look a little bit closer at the applications we're developing to make sure they can provide a longer-term solution," says Joe Fontanilles, finance manager in the strategic technologies group at Coopers & Lybrand. DATA: USAA Th e rule could also change how investors value a company. For a company that constantly invests in IT, capitalizing software costs will increase earnings and stockholders' equity. That could raise the company's stock price, make it easier to borrow, or prompt a higher takeover bid from a corporate suitor. "The failure to capture [software's] value as an asset can negatively impact the value of a company, especially during an acquisition or sale," says Anandhi Bharadwaj, assistant professor of business administration at Emory University in Atlanta. Currently, companies can choose whether to record a project's costs as expenses as they are incurred, or to capitalize the costs as an asset, then depreciate that asset over the system's useful life. Most companies use a combination of both methods, according to an InformationWeek survey of 100 IT managers. A full 75% of the companies use the expense method at least some of the time. In those cases, whatever value the software has isn't reflected on a com pany's balance sheet. Concerned about that lack of representation, especially given increasing spending on software, the Securities and Exchange Commission asked the American Institute of Certified Public Accountants to propose a standard way to treat software costs. Under the rule, which last month gained the necessary approval of the private-sector Financial Accounting Standards Board, any costs associated with a software system-including developers' salaries and the cost of packaged software-must be added together to determine the project's initial value. Some software costs- including maintenance coding, year 2000 repairs, research and development projects, and pilot tests-will still be expensed immediately because by themselves they don't create new functionality. "We think that software is truly an asset, and the income statement should reflect the use of that asset," says Daniel Noll, technical manager for accounting standards at the CPA association. Only about half of the IT managers s urveyed by InformationWeek are aware of the rule, but a clear majority-58%-say that accounting can affect project approval. Some IT executives favor the change, saying it will make it easier to win funding for software development because upper management will be more likely to approve projects whose financial impact is spread out than projects that take a bite out of one or two years' worth of earnings. DATA: INFORMATIONWEEK RESEARCH SURVEY OF 100 IT MANAGERS Hershey Foods Corp. already capitalizes most of its software costs for this reason. "We wouldn't be able to swallow all the investments we're making in applications like SAP if we weren't providing the accounting treatments," says Rick Bentz, VP of IT integration at the Hershey, Pa., company. "Business unit manager s will be much more amenable to making IT investments if they can treat them that way." Donald Walker, CIO at San Antonio insurer USAA, also favors capitalizing software costs. "If we capitalize, we can have expenses more closely match revenue," he says. The rule will also impose more discipline on the IT budgeting process, proponents say. "It provides a means for comparing future performance against projected benefits and brings greater discipline both to the software development process and to the valuation of such projects," says Emory's Bharadwaj. Budgeting for expensed projects is often less disciplined because of "scope creep," says James Hatch, VP and CIO at construction- and farm-machinery maker Case Corp. in Racine, Wis. "If you expense as costs are incurred, people have a tendency to put ballpark estimates together because they know users will change project requirements as they go," he says. "People don't get as disciplined as they might if they went through formal capitalization process." The downside: Funds from capital budgets are often harder to obtain than funds from expense budgets. All software projects now will compete with other projects funded by capital budgets, such as factory expansions. "From our perspective, capital is not as readily available," says Gene Trudell, general manager of computer services at USX Corp.'s U.S. Steel Group. "We look to conserve the use of capital expenditures as much as possible because we have a lot of things to do with our dollars, like making improvements to facilities." The greater competition for capital will force many companies to take a hard look at their priorities. "Companies will now have to balance out investments for, say, factory expansions with proposals for new IT systems," says Ron Shevlin, an analyst at Forrester Research Inc. DATA: INFORMATIONWEEK RESEARCH SURVEY OF 100 IT MANAGERS Futile Exercise? In addition to projecting costs and benefits, IT and business managers will have to predict how long applications will be used. That's a tough call to make with fast-changing technology. If the application is scrapped or replaced sooner than projected, the company will have to write off the undepreciated amount all at once-an ugly surprise for investors. The difficulty of predicting a project's fate was an argument cited by those accountants and analysts who opposed the rule. "Proponents of the expensing approach argue it is an exercise in futility to estimate the economic life and payoffs from software projects," says Emory's Bharadwaj. Some analysts who opposed the rule consider software a "soft" asset that can inflate value, adds Harrington of Coopers & Lybrand. This intangible nature of software is one reason accountants have only now decided to recognize its value in all cases, says Lowell Bryan, a partner at New York consulting firm McKinsey & Co. "The accounting profession," he says, "is not used to a world where most of the value is being added through intangibles." --with additional reporting by Bob Violino , Bruce Caldwell , and Stuart J. Johnston See related story, " Expensing Vs. Depreciation ." Back to News in Review Send Us Your Feedback Top of the Page

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