Modernized capitalization model aligned with agile development. The Financial Accounting Standards Board issued ASU 2025-06 to replace the outdated stage-based model in ASC 350-40 with a more flexible framework that reflects agile, iterative, and cloud-based software development environments.
Clear “probable-to-complete” threshold replaces rigid stages. Companies begin capitalizing internal-use software costs when management authorizes funding and it is probable the project will be completed and used as intended—provided significant development uncertainty has been resolved.
Expanded guidance for upgrades, websites, and disclosures. The update clarifies treatment of upgrades and enhancements, consolidates website development guidance (formerly in ASC 350-50), and requires internal-use software disclosures under ASC 360-10. The ASU is effective for fiscal years beginning after December 15, 2027, with early adoption permitted.
March 2, 2026
The FASB’s issuance of ASU 202506, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 35040): Accounting for Internal-Use Software represents a significant modernization of the accounting model for software developed or obtained for internal use. As organizations increasingly rely on agile development, cloudbased systems, and continuous deployment, the prior guidance no longer reflected how software is built and maintained.
Several factors drove the need for updated guidance. The current guidance was created back in 1998, when software development was still relatively new and the development style was more linear. As such, under the previous guidance in ASC 350-40, entities were required to categorize activities into three sequential stages (Preliminary project stage, Application development stage, and Postimplementation/operation stage). Based on the type of work in those stages, the Company will then either capitalize (Application Development Stage) or expense them (Preliminary project and post-implementation/operation stage). This stagebased model worked well for traditional waterfall development but became increasingly difficult to apply consistently as development practices evolved. These evolutions introduced some now challenges that make capitalization determination challenging:
Agile and iterative development blurred the boundaries between stages, making it difficult to determine when capitalization should begin or end.
Diversity in practice emerged as entities interpreted the stage definitions differently.
Cloudbased and hybrid environments introduced new types of configuration and implementation activities not contemplated in the original guidance.
As such, stakeholders expressed that the existing model required significant judgment, often leading to inconsistent capitalization outcomes between companies. Therefore, FASB responded by modernizing the guidance to better reflect today’s software development environment with ASU 2025-06.
ASU 202506 introduces targeted improvements to ASC 35040, focusing on clarity, consistency, and alignment with modern development practices. The ASU updates the model to better accommodate agile, cyclical, and iterative development, where activities do not follow a strict linear sequence by removing all references to prescriptive and sequential software development stages. Instead, an entity is required to start capitalizing software costs when both of the following requirements are satisfied (paragraph 350-40-25-12 through 25-12A of guidance):
Management has authorized and committed to funding the software project.
It is probable that the project will be completed and the software will be used to perform the function intended (referred to as the “probable-to complete recognition threshold”).
In evaluating this probable-to-complete recognition threshold, an entity should then consider whether there is significant uncertainty associated with the development activities of the software (referred to as “significant development uncertainty”). The two factors to consider in determining whether there is significant development uncertainty are:
The software being developed has technological innovations or novel, unique, or unproven functions or features, and the uncertainty related to those technological innovations, functions, or features, if identified, have not been resolved through coding and testing.
The entity has determined what it needs the software to do (for example, functions or features), including whether the entity has identified or continues to substantially revise the software’s significant performance requirements.
Capitalization of development expenses shall stop no later than the point at which a computer software project is substantially complete, including substantial testing, and ready for its intended use. For more examples from the guidance regarding how this new capitalization model can be applied, please refer to examples excerpts contained at the end of this article.
An area of concern in the software development world also relates to treatment of upgrades and enhancements after a software is launched. The guidance also addresses these concerns as well. The guidance states that for costs to be considered capitalizable, it must relate to upgrades and enhancements that introduce additional functionality. As such, if the modification does not enable the software to perform tasks that it was previously incapable of performing, it will not be considered an upgrade of enhancement and thus should be expensed as maintenance costs.
If updates and enhancements do exist, entities should determine whether these upgrades and enhancement costs should be capitalized or expensed using the guidance noted above as mentioned in the Capitalization of Project Costs section. Entities that cannot separate internal costs on a reasonably cost-effective basis between maintenance and upgrades and enhancements shall expense such costs as incurred.
The update also consolidates the guidance previously found in ASC 350-50 for website development costs into the internal-use software model, creating one unified framework for all internal-use software. Some highlights regarding website development cost include the following:
Fees incurred for website hosting, which involve the payment of a specified, periodic fee to an internet service provider in return for hosting the website on its server(s) connected to the internet, are expensed over the period of benefit.
Costs to input content (textual or graphical in nature such as articles, product photos, maps, and stock quotes and charts) into a website shall be expensed as incurred.
The costs of developing initial graphics (overall design of the web page such as use of borders, background and text colors, fonts, frames, buttons, and so forth, that affect the look and feel of the web page and generally remain consistent regardless of changes made to the content) shall be evaluated for capitalization.
Costs to register the website with internet search engines represent advertising costs and shall be expensed.
Costs to obtain and register an internet domain shall be evaluated for capitalization.
The ASU does not modify ASC 985-20 (software to be sold, leased, or marketed externally). The changes apply only to internal-use software.
Additionally, the guidance also specifies that the disclosures in Subtopic 360-10, Property, Plant, and Equipment-Overall, are required for all capitalized internal-use software costs, regardless of how those costs are presented in the financial statements and should not be presented with intangibles.
ASU 2025=06 is effective for fiscal years beginning after December 15, 2027, including interim periods within those fiscal years. Early adoption is permitted. The amendments in this Update permit an entity to apply the new guidance using any of the following transition approaches:
A prospective transition approach – Apply the new guidance only to software costs incurred on or after the date of adoption, including for in-process projects. No changes are made to prior period financial statements.
A modified transition approach – Apply prospectively to new software costs incurred, excluding the in-process projects that, as of the date of the adoption, the entity determines does not meet the new capitalization requirements but had met them in previous models. Those prior cost for in-process projects that does not meet the new guidance for capitalization will then be recorded using a cumulative-effect adjustment to the opening balance of retained earnings in the beginning of the period that is reported.
A retrospective transition approach – Apply the guidance to all prior periods presented, restating financial statements as if the new rules had always been in effect, with a cumulative-effect adjustment to the opening retained earnings of the first period presented.
This ASU is well overdue and is seen as a great update for the industry. If you have further questions or would like help seeing how this applies to your entity, please contact a trusted Larson accounting advisor.
The following is an example from the guidance that illustrates the application of the significant development probable-to-complete recognition threshold:
Example 1: Implementation and Customization of an Enterprise Resource Planning System
350-40-55-5 On February 1, 20X3, a professional services company starts internal discussions to transform its information technology by implementing an enterprise resource planning system to support finance, human resources, accounting, and client relationships.
350-40-55-6 After researching different solutions and performing its due diligence procedures, management executes a contract with a third party on August 1, 20X3, to implement and customize a hybrid solution that offers on premises software and cloud computing services for the enterprise resource planning system. Within this solution, the third party offers different functionality and features, and the company will have to make customization decisions throughout the development process to select which functionality and features it wants included.
350-40-55-7 The company assesses whether the internal and external costs to implement and customize the enterprise resource planning system meet the capitalization requirements in paragraphs 350-40-25-12 through 25-12A, as follows:
As part of its assessment under paragraph 350-40-25-12(c), the company evaluates whether there is significant development uncertainty in accordance with paragraph 350-40-25-12A. As of August 1, 20X3, the company determines that:
It has identified the significant performance requirements and does not expect to continue to substantially revise those requirements because the only expected customization is selecting from existing functionality and features.
b. The company evaluates the requirements in paragraph 350-40-25-12 to determine when to begin capitalizing software costs:
The company determines that management authorized and committed to funding the software project on August 1, 20X3, when it executed the contract with the third party.
Example 2: Development of a Mobile Application
350-40-55-9 A company is in the process of internally developing X-Crowd, which is a mobile application that will allow users to see how crowded a restaurant or store is on the basis of a user’s real-time input. An internet connection is required to be able to access the application.
350-40-55-10 On February 1, 20X1, management approved funding for internal development of the application. However, the company has not yet identified what functions and features would be included in the application. Through November 30, 20X1, the company continues to develop the functions and features of the application, including getting feedback on preliminary product versions from user groups and modifying the development of those functions and features to incorporate the feedback. On December 1, 20X1, management determines that it has identified the significant performance requirements (the significant functions and features it needs the application to have), and it does not anticipate substantial changes to those requirements. Throughout the development of X-Crowd, management determines that the application does not have technological innovations or novel, unique, or unproven functions or features.
350-40-55-11 The company assesses whether the internal and external costs to develop the application meet the capitalization requirements in paragraphs 350-40-25-12 through 25-12A, as follows:
As part of its assessment under paragraph 350-40-25-12(c), the company evaluates whether there is significant development uncertainty in accordance with paragraph 350-40-25-12A. As of February 1, 20X1, the company determines that:
It has not yet identified the significant performance requirements.
The software being developed does not have technological innovations or novel, unique, or unproven functions or features.
Therefore, as of February 1, 20X1, the company determines that significant development uncertainty exists and, in accordance with paragraph 350-40-25-12A, the software project does not meet the requirements to begin capitalizing software costs in paragraph 350-40- 25-12(c)
b. As of December 1, 20X1, the company determines that:
It has identified the significant performance requirements and does not expect to continue to substantially revise those requirements.
The software being developed does not have technological innovations or novel, unique, or unproven functions or features.
Therefore, as of December 1, 20X1, the company determines that significant development uncertainty has been resolved.
c. As of December 1, 20X1, the company evaluates the requirements in paragraph 350-40-25-12 to determine when to begin capitalizing software costs:
The company determines that management authorized and committed to funding the software project on February 1, 20X1, when it approved funding for internal development of the application.
Considering all other relevant facts and circumstances, as of December 1, 20X1, the company determines that it is probable that the software project will be completed and the software will be used to perform the function intended.
350-40-55-12 As a result, on December 1, 20X1, the company determines that the capitalization requirements in paragraphs 350-40-25-12 through 25-12A are met, and it begins capitalizing eligible software costs.
Example 3: Development of a Novel Technology
350-40-55-13 On January 1, 20X1, a software development company starts discussions to develop software with novel functionality.
350-40-55-14 On February 1, 20X1, management completes its due diligence procedures, approves a budget to internally develop the software, and allocates an internal development team to start developing the novel software. At the time that the company started discussions and management approved a budget, the software still had novel functionality.
350-40-55-15 On March 1, 20X3, the company resolves the uncertainty related to the novel functionality through coding and testing. Additionally, on March 1, 20X3, the company determines that it does not expect substantial changes to the identified significant performance requirements (the significant functions and features) included in the software. On April 1, 20X3, the company determines that all substantial testing is completed.
350-40-55-16 The company assesses whether the internal and external costs to develop the software meet the capitalization requirements in paragraphs 350-40-25-12 through 25-12A, as follows:
As part of its assessment under paragraph 350-40-25-12(c), the company evaluates whether there is significant development uncertainty in accordance with paragraph 350-40-25-12A. As of February 1, 20X1, the company determines that:
It has not yet identified the significant performance requirements.
The software being developed has novel functionality and that functionality has not been resolved through coding and testing.
Therefore, as of February 1, 20X1, the company determines that significant development uncertainty exists and, in accordance with paragraph 350-40-25-12A, the software project does not meet the requirements to begin capitalizing software costs in paragraph 350-40- 25-12(c).
b. As of March 1, 20X3, the company determines that:
It has identified the significant performance requirements and does not expect to continue to substantially revise those requirements.
The uncertainty related to the novel functionality has been resolved through coding and testing.
Therefore, as of March 1, 20X3, the company determines that significant development uncertainty has been resolved.
c. As of March 1, 20X3, the company evaluates the requirements in paragraph 350-40-25-12 to determine when to begin capitalizing software costs:
The company determines that management authorized and committed to funding the software project on February 1, 20X1, when it approved a budget and allocated an internal development team.
Considering all other relevant facts and circumstances, as of March 1, 20X3, the company determines that it is probable that the software project will be completed and the software will be used to perform the function intended.
Example 4: Development of a Website
350-40-55-18 An animal rescue organization starts discussions on June 15, 20X5, to develop a website that will be used to share information with users of the organization, including hours of operation, contact details, animals available for adoption, and standard adoption procedures
350-40-55-19 After researching different website developers and performing its due diligence procedures, management executes a contract with a third party on August 1, 20X5, to develop a website for the organization. The third party is an established website developer and offers different templates that the organization can use to create its website. In addition to website development fees paid to the third party, the organization incurs costs:
To obtain and register an internet domain
To input content into the website
To develop initial graphics for the website
To register the website with internet search engines
For ongoing website hosting fees.
350-40-55-20 The organization assesses whether the internal and external costs to develop the website meet the capitalization requirements in paragraphs 350-40-25-12 through 25-12A, as follows:
As part of its assessment under paragraph 350-40-25-12(c), the organization evaluates whether there is significant development uncertainty in accordance with paragraph 350-40-25-12A. As of August 1, 20X5, the organization determines that:
It has identified the significant performance requirements and does not expect to continue to substantially revise those requirements because the website will be created from existing templates that the organization can use to share the information described in paragraph 350-40-55-18.
The website being developed does not have technological innovations or novel, unique, or unproven functions or features because it will be developed from existing templates.
Therefore, as of August 1, 20X5, the organization determines that significant development uncertainty does not exist.
b. The organization evaluates the requirements in paragraph 350-40-25- 12 to determine when to begin capitalizing costs:
The organization determines that management authorized and committed to funding the development of the website on August 1, 20X5, when it executed the contract with the third party.
Considering all other relevant facts and circumstances (for example, the organization has engaged an established and experienced third party to develop the website), as of August 1, 20X5, the organization determines that it is probable that the project will be completed and the website will be used to perform the function intended.
350-40-55-21 As a result, on August 1, 20X5, the organization determines that the capitalization requirements in paragraphs 350-40-25-12 through 25-12A are met, and it begins capitalizing eligible costs. In evaluating which costs are eligible for capitalization, the organization determines the following:
Fees paid to the third party for services to develop the website are evaluated for capitalization in accordance with paragraph 350-40-30-1.
Costs incurred to obtain and register the internet domain are evaluated for capitalization in accordance with paragraph 350-40-25-17J.
Costs incurred to input content into the website are expensed as incurred in accordance with paragraph 350-40-25-17G.
Costs incurred to develop initial graphics for the website are evaluated for capitalization in accordance with paragraph 350-40-25-17H.
Costs incurred to register the website with internet search engines are expensed as incurred in accordance with paragraph 350-40-25-17I.
Ongoing website hosting fees are expensed over the period of benefit in accordance with paragraph 350-40-25-17F.
For additional guidance on this topic, contact the Larson & Company Small to Medium Sized Businesses Team. We have developed a suite of services specifically to serve the needs of companies of all sizes in a wide range of industries.
When should companies begin capitalizing internal-use software costs under ASU 2025-06?
Companies should begin capitalizing costs when management has authorized and committed funding and it is probable the software will be completed and used as intended. Capitalization can only begin once significant development uncertainty—such as unresolved novel functionality or undefined performance requirements—has been resolved.
How does ASU 2025-06 change the old stage-based capitalization model?
ASU 2025-06 eliminates the rigid preliminary, development, and post-implementation stages under ASC 350-40. Instead, it introduces a principles-based “probable-to-complete” recognition threshold better suited to agile and iterative development.
Are software upgrades and enhancements capitalized?
Only upgrades and enhancements that add new functionality may be capitalized. Routine maintenance, bug fixes, and minor updates that do not expand functionality must be expensed as incurred.
How are website development costs treated under the new guidance?
Website development costs now fall under the internal-use software model. Development fees and certain graphics or domain registration costs may qualify for capitalization, while hosting fees, search engine registration, and content input costs are expensed.
When is ASU 2025-06 effective and what transition methods are allowed?
The ASU is effective for fiscal years beginning after December 15, 2027, including interim periods. Entities may adopt prospectively, through a modified transition approach with a cumulative-effect adjustment, or retrospectively by restating prior periods.