Generally Accepted Accounting Principles
In most cases, the GAAP rules that affect IT require that managers pay closer attention to what IT projects are supposed to accomplish because the nature of the work affects how its cost will be treated for accounting purposes. And IT managers must pay closer attention to how IT workers divide their time among projects because labor hours for some projects may have to be accounted for differently than labor hours for others.
Paul Munter, chairman of the accounting department at the University of Miami school of business administration in Florida, helped write recent GAAP guidelines, known as Statement of Position (SOP) 98-1, on how to account for development costs of software being designed for internal use [Business, Oct. 18].
The fundamental issue for IT managers "is trying to identify what things your people are working on. Because some of their time can be capitalized and some of it cannot," says Munter. Capitalized costs are written off against profits over several years. Expensed costs are written off immediately against current profits.
"Suppose an IT person is working on implementing a new software product or working on testing a new software product. That person’s salary for time spent that way is a capitalized cost," Munter says. "But if that IT person is training others on how to use software, the salary for that time would be expensed."
While such accounting rules might appear puzzling at first, Munter says they’re logical. Because companies can’t function without software, the time spent implementing or testing new software is considered part of the creation of an asset that will benefit the company for several years. As a result, those labor costs are capitalized over several years.
But training costs are expensed because they’re considered a cost of doing business rather than a cost of creating an asset. Under the same theory, software maintenance costs are also a part of doing business and therefore should be expensed.
"IT people are not used to tracking things in this way. It’s not a superhuman task, but unquestionably it’s a change in practice for the IT profession," Munter says. But there are benefits to IT as well. "Once you start keeping track of your IT people, you start knowing how they spend their time."
Companies that design software that will be sold face more relaxed accounting rules because of something called the "technology feasibility rule," Munter says.
Although companies that develop software for their own use must immediately begin capitalizing payroll costs associated with developing it, that isn’t true for software firms developing products for sale. Software firms don’t have to capitalize their payroll costs until a product is proved to be technically feasible, Munter says. Typically, the majority of software development costs occur before technical feasibility is proved, so software companies can be much less concerned about keeping track of the payroll costs associated with software development.
Leasing Vs. Owning
Another GAAP rule that affects IT managers is FASB 13 lease capitalization from the Financial Accounting Standards Board (FASB.) It defines ways of handling computer equipment leases, says Greg Uchimura, manager of cost accounting at GTE Data Services in Temple Terrace, Fla.
Here’s the rule: If equipment is leased for a year at a time, it’s not considered to be an asset. As a result, its cost must be treated as an expense taken out of current profits. But if the lease contract contains what might be considered "bargain" terms for converting the lease to a purchase, GAAP rules assume that the leased computer equipment is an asset that must be capitalized, or written off against profits, over a period of several years.
"Under the FASB ruling, [the latter case] is considered to
be ‘constructive ownership’ because the lease is so preferential [toward a purchase] that the assumption is you will exercise it. The idea is that you’d be a fool not to buy, therefore you own it," says Uchimura.
AT A GLANCE
Key Rules For IT
Two important GAAP rules that apply to IT organizations:
SOP 98-1: Defines how to account for development costs of software being designed for internal use.
FASB 13 lease capitalization: Defines ways of accounting for computer equipment leases.
Sometimes, GAAP rules combine to create more work for IT managers. One rule, developed in 1997, deals with business process re-engineering costs that are incurred at the same time as a major systems implementation, says Dave Kaplan, co-director of national accounting consulting services at PricewaterhouseCoopers in Florham Park, N.J. The rule says all business process re-engineering costs have to be expensed, or charged against current profits, at the time they’re incurred.
The idea behind the rule is that, as part of implementing enterprise resource planning systems, a firm will change its business methods (or re-engineer processes) to maximize the new computer system’s efficiency. For example, if a new human resources system is being installed, some work that was done by hand may become automated.
But that rule has some interesting effects when considered with SOP 98-1. The problem is this: IT managers now must distinguish between the costs of implementing a new computer system that are related to business process re-engineering, and therefore would beexpensed, and software development costs that would be capitalized under SOP 98-1, says Kaplan, who was on the committee that wrote SOP 98-1.
"These costs often occur in the same project, so the question is, which costs does one expense or capitalize?" Kaplan says. "And some people think accounting is easy."
Alexander is a freelance writer in Edina, Minn.
GAAP: The Basis for Financial Reports
The original GAAP doctrine was set forth by the Accounting Principles Board of the American Institute of Certified Public Accountants, which was superseded in 1973 by the FASB, an independent, self-regulating organization.
GAAP is the basis for preparing and reporting information that is included in the financial statements a company distributes to its shareholders. But when it comes to calculating income for tax purposes, a company may be called upon to use different methods based on tax law and Internal Revenue Service rulings. IRS rules frequently differ from GAAP.