For technology companies, innovation is the engine of growth, and that innovation often comes with significant software development costs. How these costs are accounted for can have a major impact on your company’s financial statements, profitability, and investor perceptions.
When software is developed in-house, it can be tricky to determine whether the cost of the development is a capital expenditure or an expense. It can be even trickier to support your position when undergoing your audit.
What Auditors Want to See
Many startup companies deprioritize labor documentation early in their lifecycle. This can create significant challenges as they undergo their first audit. When auditors review software development costs, they’re looking for more than just numbers on a spreadsheet.
Your auditor is focused on compliance with accounting standards, consistency with industry practices, and the presence of robust supporting documentation. Auditors will scrutinize your company’s capitalization policies, compare them to industry norms, and assess whether the costs being capitalized meet the criteria of GAAP standards.
For a deeper dive into the specific accounting rules for software development, see our article, Accounting for Software Development Costs in the Technology Industry.
Acceptable Documentation
The foundation of any successful audit is thorough documentation. You will need to show your auditor a reconcilable trail, related to software development costs, that includes:
- Who did what, when, and for which project
- Project-level documentation with clear timelines
- Ties into complete data sets, such as time and payroll data
There are several methods to ensure you have this information ready for your auditor:
- Time tracking: On an employee level, track the time spent on development projects throughout the year.
- Project-based staff allocations: Allocate employee time to projects based on a percentage allocation method.
- Project tracking software: Software such as Jira can be useful in determining hours spent on various development projects.
In all of the above methods, this information can be integrated with payroll data to allocate payroll costs to your organization’s projects. The finance and engineering teams then need to collaborate on which projects can be capitalized, and which should be expensed in accordance with GAAP.
Finding alignment and understanding between the finance and engineering teams can be a common challenge with these methods.
The Ideal: Consistent Time Tracking That Cross-References Easily
Auditors prefer systems that allow them to match general ledger data, payroll, and project output. Time tracking that captures all work, not just capitalizable tasks, allows for better cross-comparisons and audit readiness. A robust understanding of each project is essential in determining whether related costs should be capitalized or expensed.
Software Highlight: ClickTime
ClickTime is a time tracking system that reduces audit prep burden. With ClickTime, technical teams don’t need to remember what they worked on or worry about whether their projects are capitalizable. Their existing tools, like calendars and Jira boards, translate directly into hours worked to intelligently capture where time was spent, so they never need to spend Friday afternoon guessing how they spent their week.
Finance then applies its own logic layer, ensuring each new hour logged is routed to the right cost center. Time entries flow straight into payroll, while reports stay aligned with the GL and audit requirements.
Final Advice on Avoiding Last-Minute Scramble
First and foremost, get your finance and engineering teams aligned before audit season to ensure you have the data and understanding needed to support your determinations. Use a tool that tracks time, ties into payroll, and produces a complete dataset.
Developing good processes with clean documentation early in your company’s life cycle adds operational maturity, not just for cost capitalization, but for all of your financial reporting.
Need help? Our team of experts is available to support you and ensure you have the right processes in place. Get in touch with our technology audit team today.
