Computer equipment is considered one of the most significant components of fixed assets items in an entity’s balance sheet. This kind of asset usually has more than twelve months and classified as non-current assets, initially recognized at cost and subsequently value at cost less depreciation and impairment.

The classification, measurement, and recognition of computer equipment in balance sheet are detail discussed below

Classification

Computer Software is considered to be a significant asset on the financial statements of the company. It is considered a non-current asset classified alongside other fixed assets like property, plant, and equipment. Even though it is not tangible or physically present, it is considered an important non-current asset because it derives utility for a fairly long time span, mostly for more than 12 months. In the same manner, this is a high cost that the company incurs, and therefore, it makes sense for organizations to capitalize on this particular cost.

Therefore, accounting bodies have allowed companies to capitalize software costs as non-current assets in the balance sheet. However, not all software can be capitalized. The respective software needs to meet certain criteria to ensure that they are properly treated and classified as property, plant, and equipment.

When it comes to classifying computer software, certain criteria need to be followed to ensure that it is correctly categorized into either tangible assets or intangible assets. Intangible assets are mainly nonphysical assets that derive utility for the company for a longer time period. They are mostly intellectual assets that the company possesses. In most cases, it is quite difficult for companies to assign a value to these particular assets because there is relative uncertainty regarding the material benefits that will be derived from them.

On the other hand, tangible assets are physical in nature. They are measurable, and therefore, are used in the company’s operations. Examples of intangible assets include property, plant, and equipment.

Under most situations, computer software is classified as an intangible asset because it is not of physical nature, and therefore, accurate monetary benefits cannot be derived. However, certain accounting rules allow computer software to be classified as a tangible asset under Property, Plant, and Equipment.

Recognition

As mentioned earlier, it can be seen that computer software is only supposed to be capitalized in the balance sheet if it meets certain criteria. If this particular criterion is not met, the company should record the computer software cost as an expense in the Income Statement. The criteria under which computer software can be recorded as property, plant, and equipment is given below:

  • The computer software must have a life of more than two years.
  • The computer software must not be purchased to resell it. In other words, the company should not be in the business of reselling software as a part of its normal operations.
  • The given software that intends to be capitalized must be purchased or constructed to be used for the given entity.

If the computer software meets the aforementioned criteria, in that case, it can be classified as a tangible asset in the books of the company.

The computer software is recognized in the financial statements (and the company’s balance sheet) once the risk and rewards associated with ownership of the company software have been transferred. This implies that capitalization (or recording) or computer software cost is really not contingent on the company has paid for the cost of the asset itself.

There is also a difference in this regard between purchased software, and software that is internally created or built by the company.

When it comes to purchased software, it can be seen that the process of capitalization of purchased software cost is relatively straightforward in the sense that it is regarded as a one-time, upfront cost. Therefore, it makes sense to capitalize it in an upfront manner.

On the other hand, companies also can build their own computer software, which requires a certain amount of time and the cost associated with building the required software. In this case, capitalization of these costs needs to be subject to proper treatment. This is essential because of the reason that several different phases are involved in a software development-related spree. In this regard, companies are only supposed to capitalize costs when they can ascertain with proper certainty that the software development will be successful, and there will be no issues about the development costs being wasted. Hence, in the case of internal software development, the process is slightly different. Costs are not capitalized upfront and can only be done if a significant amount of work has already been executed on the particular software.

Measurement

Computer Software, although is intangible, comes with certain useful life. In the financial statements, the carrying value of the computer software is used in order to reflect the actual value of the asset that the company possesses.

However, the software does not really depreciate over time. Unlike items of physical nature that go through wear and tear, the software does not render any depreciation over time. Regardless, it must be noted that computer software is still vulnerable to get outdated over time. As a result, it is important to amortize the given computer software over time. It is tantamount to realize that computer software might change in valuation and might bear the risk of being outdated. Therefore, companies are supposed to amortize the software cost to reflect the usage of software over time.

Therefore, the asset’s carrying value is mostly the difference between the historical cost (the purchase amount of the asset) and the accumulated amortization. For different software, there are different amortization rates and methodologies. However, for most computer software, the general amortization rate is 3 years (or 36 months).

Example of Computer Software in the Balance Sheet

Computer Software is considered a very resourceful asset because it greatly impacts the overall ability of the business to generate considerable profits. It is mentioned in the balance sheet (if it meets the capitalization criteria) at its carrying cost. This is explained with the help of the illustration given below:

Moby Corporation has purchased computer software that is going to help them increase their production efficiency. Consequently, the company decided to capitalize the asset in its financial statements. The software costs $30,000 to implement. The company further decided on amortizing the asset over a period of 3 years, evenly across all years.

In the example above, it can be seen that the cost of purchasing the asset amounted to $30,000. After every year, the amortization cost will reduce by $10,000 since the software is supposed to be amortized over three years. Therefore, the annual amortization amounts to be $10,000. It is presented in the Balance Sheet in the following manner:

  Amount ($)
Computer Software$30,000
Accumulated Amortization($10,000)
Computer Software – Net Amount$20,000

Therefore, it can be seen that software development and capitalization are contingent on a couple of different aspects. The amortization rate (or period), for example, is one such factor that impacts the overall capitalization of the said software. In the same manner, it can also be seen that in the case where the life of the software is expected to be less than 2 years, in that case, the software is not capitalized on the balance sheet as a non-current asset.