In September 2025, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2025-06: Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software. This ASU supersedes the project stages described below and requires an entity to start capitalizing software costs when both of the following occur:
1) Management has authorized and committed to funding the software project.
2) 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 the probable-to-complete recognition threshold, an entity is required to 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 whether:
1) 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, has not been resolved through coding and testing.
2) 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.
The ASU is effective for all entities for annual reporting periods beginning after December 15, 2027, and interim reporting periods within those annual reporting periods. Early adoption is permitted as of the beginning of an annual reporting period. If this ASU is not early adopted, the existing guidance should be followed until this ASU is adopted.
In sticking with the project stage example below, assuming the two criteria for capitalization have been met (the project has been authorized and it’s probable of being completed), there would likely be no change in the conclusions reached. In other words, the API design costs would still be capitalized. The training costs would still be expensed in accordance with ASC 350-40-25-4, which explicitly states internal and external training costs are not internal-use software development costs and shall be expensed as incurred. And the ongoing maintenance costs would also be expensed as incurred (ASC 350-40-25-17C indicates maintenance costs shall be expensed as incurred).
A financial institution’s core banking system, or core processing system, is an essential software that provides the backbone for day-to-day operations and transaction processing. Accounting for the costs of these systems can be tricky because of the complexities often involved in these contracts.
The contracts tend to be long-term, as it would be infeasible (and undesirable) for financial institutions to have to re-negotiate and possibly switch core providers on a frequent basis. In addition, the contracts often include varying fees and provisions listed throughout the contract. The accounting team is often provided this lengthy contract and then left with the task of deciphering what is meaningful from an accounting standpoint.
There are two key pieces of accounting guidance to consider when analyzing core contracts:
1) Accounting Standards Codification (ASC) 705 – Cost of Sales and Services
2) ASC 350-40 – Intangibles – Goodwill and Other – Internal-Use Software
Core contracts may provide incentives or credits that can be applied against the fees charged by the core provider. According to ASC 705-20-25-1, “consideration from a vendor also includes credit or other items (for example, a coupon or voucher) that the entity can apply against amounts owed to the vendor (or to other parties that sell the goods or services to the vendor). The entity shall account for consideration from a vendor as a reduction of the purchase price of the goods or services acquired from the vendor…”
As an example, let’s say your financial institution receives a one-time credit as part of signing a new core contract of $100,000 and the contract is to provide services to your institution over five years. This credit can be applied to future invoices received from the core provider. The contract has a monthly maintenance fee of $20,000 (likely among other charges). This credit would thus reduce the monthly maintenance expense of $20,000 to $18,333 (reduced by $100,000 divided by 60 months). This is a simple example, but hopefully, it will provide insight into the mechanics of the accounting for credits and incentives. In reality, these contracts tend to be much more complex, with variable fees and possibly even credits or incentives that can only be applied against certain fees. These credits/bonuses may not be recognized fully up front as a gain, revenue, or reduction of expense.
There are often many fees listed in a core contract and these fees tend to be for various services related to the contract. Each fee should be considered on its own and assessed against the criteria listed in ASC 350-40-25, which establishes three project stages for internal-use software:
1. Preliminary Project Stage. This stage may include:
a. Conceptual formulation of alternatives
b. Evaluation
c. Determination
d. Final selection
All costs associated with the preliminary project phase shall be expensed as incurred.
2. Application Development Stage. This stage may include:
a. Design
b. Coding
c. Installation
d. Testing
Whether or not costs in this stage shall be expensed or capitalized is dependent on the type of cost:
- Costs incurred to develop internal-use software shall be capitalized.
- Costs to develop or obtain software that allows for access to or conversion of old data by new systems shall be capitalized.
- Training costs shall be expensed as incurred.
- Data conversion or clean-up costs shall be expensed as incurred.
- Postimplementation-Operation Stage. This stage may include:
a. Training
b. Application maintenance
All costs associated with the post-implementation-operation stage shall be expensed as incurred.
Costs incurred for upgrades and enhancements to internal-use software shall be expensed or capitalized in accordance with the guidance provided above. Costs incurred for maintenance shall be expensed as incurred.
As an example in applying the above project stages, let’s say your institution has hired your core provider to develop an application programming interface (API—essentially a “bridge” between two software programs, allowing them to “talk” to one another) so a new automated account reconciliation software can interface directly with your core. The core provider is charging you directly for the design of this API. These costs would be capitalized. Once designed, the core provider also provides your institution training on the API (for a fee)—these training fees would be expensed. Any internal training expenses, such as ongoing training, would be expensed as incurred. Furthermore, if your core provider charges a maintenance fee for ongoing maintenance of the API, these fees would also be expensed as incurred.
Given these core contracts and the fees associated with them can be quite voluminous, it is best practice to establish a list of the services and associated fees listed in the contract. An accounting determination can then be made in accordance with ASC 705 and 350-40 and listed next to each service/fee. Such a list can also be helpful in tracking the various credits and incentives that are being provided and how much of these credits and incentives remain to be utilized by your financial institution.
It should be noted that the FASB has an ongoing project related to the accounting for and disclosure of software costs. More details and a current status update on the project can be found on the FASB website. A proposed ASU was issued in October 2024 and a final ASU, as noted at the top of this article, was issued in September 2025. The ASU eliminates the project stages detailed above. Instead, costs will start to be capitalized when both of the following occur:
- 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”).
Although financial institutions may early adopt this ASU (which is effective for annual reporting periods beginning after December 15, 2027, and interim reporting periods within those annual reporting periods), those that do not early adopt should continue to follow the project stage guidance detailed above in assessing the accounting treatment for the fees in their core contracts. As always, your BerryDunn team is here to help should you have any questions!