Technological advancements allow businesses to take advantage of new efficiencies, improved communication, and robust applications. However, these benefits often bring numerous complexities and issues, such as the accounting treatment of data conversion activities, which often accompany new software implementation projects.
Deciding whether the costs related to data conversion should be capitalized or expensed is a nuanced decision. Management must consider the method of conversion, the mode of access, and the future use of the data to properly account for the associated costs.
Although the accounting treatment varies based on the situation, there are three common scenarios associated with data conversion costs. In each of the following scenarios, management intends to replace the old system with a new one.
Scenario One: Management does not want to clog up the new system with years of historical data. Thus, it decides to use the time of internal employees or external contractors and consultants to manually enter selected historical data from the old system into the new. In this scenario, all costs for the data conversion are to be expensed as incurred.
Scenario Two: Management decides that manually entering the desired historical data would be too time-consuming and susceptible to human error. Therefore, it chooses to write or purchase software that will recode data from the old system into a format that can be uploaded automatically into the new system. The costs associated with the creation of software to recode the data are to be capitalized.
These capitalized costs are amortized over the period that the data conversion software will be used. Since the purpose of the software is solely to recode data from the old system to the new, the amortization period is typically short and often occurs within the same year the writing or purchase costs were capitalized. However, it is critical to treat this differently from Scenario One to ensure amounts are recognized in the proper period, due to the timing and cutoff associated with financial reporting. Management must also consider whether the data conversion software will be utilized for future system conversions or other applications. If determined it will be, then the amortization period of the associated costs will be extended to cover the expected future use.
Scenario Three: Management decides it does not want any of the old data to exist within the new system. Instead, the new system must communicate with and access the old system to view historical data in real time. Like Scenario Two, this would require the creation of separate software to bridge the old and new systems. The costs associated with the creation of this software are to be capitalized.
These capitalized costs are amortized over the period that the bridge software will be used. Unlike Scenario Two, the period of use will often extend beyond one year, as it is often necessary for management to have access to the old system for multiple years. This period of amortization will sometimes extend to the full life of the new system and may sometimes be shorter. Management should also consider the method of amortization for the bridging software. As time passes, the new software may need less and less access to the old system, which could prompt management to amortize the associated costs in a manner other than the straight-line method.
In each scenario, management can provide access to desired historical data. However, regardless of the situation, the accounting treatment of the costs incurred in order to provide that access is unique. So, the next time you are considering the age-old question related to data conversion costs—“Expense it or not?”—you know the answer: “Well, it depends. . . .”
For more information about customer accounting for data conversion activities, or assistance with any matter involving audit and assurance, accounting, or business advisory, contact one of our PYA executives below at (800) 270-9629.
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