Key Takeaways
- Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2025-06 modernizes internal-use software accounting replacing stage-based rules with a probable-to-complete threshold tied to development uncertainty.
- ASU 2025-06 shifts timing and classification of software costs, increasing expensing and affecting earnings and assets while enhancing disclosures under Accounting Standards Codification (ASC) 360.
- Entities may adopt ASU 2025-06 using prospective, modified or retrospective methods, with a 2027 effective date, requiring updated policies, stronger controls and proactive lender communication on EBITDA impacts.
As companies continue to invest heavily in technology, the Financial Accounting Standards Board’s (FASB) new internal-use software guidance provides an opportunity to simplify how software development costs are evaluated, capitalized and disclosed. Navigating the new guidance will help companies simplify their approach to software capitalization and provide clarity on financial statement disclosures that are more aligned with today’s modern software technology development landscape. Understanding the new standard, key changes from legacy guidance and the available adoption methods will help entities simplify their approach and be better planned for what is ahead.
The New Standard
Accounting Standards Update (ASU) 2025-06: Intangibles – Goodwill and Other Internal-Use Software was released by the FASB on September 18, 2025. The new guidance serves as a targeted improvement to the accounting for Internal-Use Software and is intended to improve and modernize the operability of the standard. The previous guidance has become cumbersome as it has relied on prescriptive software project stages and did not align well with the contemporary iterative development methods and created many application challenges for entities.
ASU 2025-06 will reshape how these transactions are presented in the financial statements, possibly impacting both the timing and classification of reported results. Companies could see changes to key metrics such as earnings, assets and liabilities, along with enhanced financial statement disclosures providing greater transparency into underlying assumptions and risks.
Key Changes
The guidance has removed all references to prescriptive and sequential development stages. Moving forward, in order to start capitalizing software costs, the following must occur:
- Management has authorized and committed to the funding of the project.
- It is probable that the project will be completed, and the software will be used to perform the function intended. This concept is referred to as the “probable-to-complete” recognition threshold.
ASU 2025-06 adds guidance on assessing the “probable-to-complete” threshold by requiring entities to consider whether significant development uncertainty exists. Significant development uncertainty exists if either (a) the software involves technological innovations, novel or unproven features unresolved by coding and/or testing, or (b) significant performance requirements are not identified or are being substantially revised. If this uncertainty exists, the threshold would not be considered to be met, and the related development costs must remain expensed.
The separate intangible asset disclosures required by ASC 350-30 are no longer applicable for internal-use software under the new guidance. All capitalized internal-use software costs must follow the disclosure requirements in ASC 360-10 (Property, Plant, and Equipment), regardless of how those costs are presented in the financial statements.
It is important to note that the capitalizable costs remain unchanged from previous guidance. As a reminder, capitalizable costs need to be directly attributable to the internal-use software development. Such costs include payments to external developers and vendors, as well as payroll costs of internal personnel involved in coding, configuration and testing.
Adoption Methods
The FASB has permitted an entity to apply one of the following transition approaches:
- A prospective approach: An entity would apply the amendments to new software costs incurred at the beginning of the adoption period.
- A modified transition approach: Based on the status of the project and whether software costs were capitalized before the date of adoption. The entity applies the new guidance prospectively to all software costs incurred after adoption. This includes costs for existing in-process projects. For any in-process project that was capitalized under the old guidance, but does not meet the new capitalization criteria at the time of adoption, the previously capitalized balance for that project is written off through a cumulative-effect adjustment to opening retained earnings as of the date of adoption.
- A retrospective transition approach: Entities should recast comparative periods and recognize a cumulative-effect adjustment to the opening balance of retained earnings as of the start of the first period presented.
Effective Date
ASU 2025-06 is effective for annual periods beginning after December 15, 2027, including interim periods within those years. Early adoption is permitted at the beginning of an annual period.
Potential Impacts
As this standard is tightening the criteria for capitalization, it is possible to see more costs expensed rather than capitalized. With more potential for upfront costs being recognized, the standard has the potential to put pressure on covenants especially those tied to EBITDA. Companies should model the impact of the standard early on in the process to understand how their key metrics will change. Proactive communication with lenders is critical to determine if covenant terms or definitions can be adjusted for accounting-driven changes.
Companies can reduce the risk of inconsistent or aggressive capitalization by establishing clear accounting policies aligned with ASU 2025-06 and applying them consistently. Additionally, strengthening internal controls, including a formal review and approval process, ensures costs are evaluated prior to capitalization.
How We See It
We see this shift in Internal-Use Software Capitalization as a valuable move from rigid, stage-based accounting toward a model that is driven by principles that better reflect how software is developed today. By tying capitalization to a “probable-to-complete” threshold, the guidance more accurately aligns with agile and iterative developments seen in industry today. In our view, this both streamlines application in practice but also improves the consistency and transparency of the costs that are capitalized, which helps deliver business leaders more meaningful financial reporting.
Contact Us
Our team at PKF O’Connor Davies is ready to assist you with the implementation. We provide services ranging from review of current capitalization policies and procedures to identification of gaps in controls to help prepare these methods for ASU 2025-06. We can also assist with implementation of monitoring activities and training to help management apply the guidance consistently.
If you have any questions, please contact your client service team or:
Michael Mekler, CPA
Director
mmekler@pkfod.com | 781.937.5110
Michael Ruggiero, CPA
Partner
mruggiero@pkfod.com | 203.705.4127