ASC 985-20

ASC 985-20 governs how companies account for the cost of building software they intend to sell. Software companies, and any business that develops software products for customers, follow it to decide which development costs are expensed as research and development and which are capitalized as an asset. The key concept is technological feasibility: costs incurred before it is established are expensed, while qualifying costs incurred after it, until the product is released, are capitalized.

ASC 985-20 sits alongside ASC 350-40, which covers software developed for internal use. The two have different rules, so the intended use of the software determines which standard applies. For IT financial management, ASC 985-20 matters to technology and product companies, and to any organization that develops software for customers, because it affects reported R&D expense, assets and profit.

Definition of ASC 985-20

ASC 985-20, Software, Costs of Software to Be Sold, Leased, or Marketed, is the subtopic of the FASB Accounting Standards Codification that covers the costs of computer software that is sold, leased or otherwise marketed, whether separately or as part of a product or process.

It applies to software that the company intends to sell or license to customers. Software developed solely for internal use, with no substantive plan to market it, falls under ASC 350-40 instead.

Technological Feasibility

Technological feasibility is established when the company has completed all the planning, designing, coding and testing activities necessary to establish that the product can be produced to meet its design specifications. This is typically demonstrated by completing a detailed program design or, in its absence, a working model.

Costs incurred before technological feasibility, such as research, design and early development, are expensed as research and development. Costs incurred after technological feasibility and before the product is available for general release to customers are capitalized.

In practice, many software companies reach technological feasibility very late, close to release, especially when using agile methods with a working model approach. As a result, the amount capitalized under ASC 985-20 is often small.

Amortization and Impairment

Once the product is released, capitalized costs are amortized. The annual amortization is the greater of the amount calculated using the ratio of current revenue to total current and anticipated future revenue, or the straight-line method over the remaining estimated economic life of the product.

Like other capitalized software, these costs are amortized rather than depreciated, and they are reviewed for impairment through a specific test. Capitalized costs are subject to a net realizable value test at each balance sheet date. If the unamortized cost exceeds the estimated future revenue from the product, less the costs to complete and sell it, the excess is written off.

Costs incurred after release, such as maintenance and customer support, are expensed as incurred.

Importance of ASC 985-20 in IT Financial Management

For companies that sell software, development is often their largest cost. How it is treated under ASC 985-20 affects reported R&D expense, gross margin, operating income and the assets on the balance sheet.

The distinction between ASC 985-20 and ASC 350-40 also matters as business models change. A company that shifts from licensed products to subscriptions may find that the same engineering work is now governed by a different standard, with a different point at which capitalization begins.

Investors often compare R&D spending across software companies, so consistent and well-documented application of the standard supports credible financial reporting.

Software Sold vs Software as a Service

Software delivered as a service, where customers access it over the internet without taking possession, is generally treated as internal-use software under ASC 350-40, since the company uses the software to provide a service rather than selling the software itself.

This means that a company moving from selling licensed software to offering SaaS may shift from ASC 985-20 to ASC 350-40 for its new development. The two standards have different capitalization thresholds, so the change can affect how much development cost is capitalized.

ASC 350-40 was itself updated by ASU 2025-06, while ASC 985-20 was not, so the gap between the two models remains relevant.

Tax and Reporting Differences

Whatever the book treatment, software development costs are generally treated as research and experimental expenditures for US tax purposes under Section 174. Book and tax treatment can therefore differ, creating deferred tax items.

Understanding these differences helps finance and technology leaders explain why reported R&D expense, taxable income and cash flow can move differently.

For companies with both product and internal software development, tracking which projects fall under each standard is essential for accurate reporting.