FASB Accounting Standards Update (ASU) 2025-06, issued in September 2025, represents a major modernization of the accounting for internal-use software. The update moves away from rigid, stage-based models toward a principles-based framework that better aligns with modern development practices like Agile and DevOps.
Key Changes Under ASU 2025-06
The primary shift in ASU 2025-06 is the removal of the “project stage” model (Preliminary, Application Development, and Post-Implementation). Instead, capitalization now begins when two specific criteria are met:
- Management Authorization: Leadership implicitly or explicitly authorizes the project and commits to its funding.
- Probable-to-Complete Threshold: It is probable the project will be finished and the software will perform its intended function.
A critical new concept is significant development uncertainty. If a project involves novel, unproven technology or if performance requirements are still being substantially revised, capitalization must be delayed until these uncertainties are resolved.
Application Examples
Example 1: Standard ERP Implementation
On January 1, a company decides to replace its legacy ERP system. On July 1, it signs a contract with a vendor for a known, standard software solution requiring only minor configuration.
- Analysis: Capitalization begins July 1. Management has authorized the project through the contract, and because the software is a proven solution, there is no “significant development uncertainty.”
Example 2: Novel AI Feature Development
On February 1, a tech firm approves a budget to develop a first-of-its-kind generative AI tool for internal data analysis. The team begins coding, but the core functionality is unproven. By July 1, testing confirms the tool can successfully perform the required tasks.
- Analysis: Capitalization begins July 1, not February 1. While management authorized the project in February, “significant development uncertainty” existed until the novel functionality was proven through testing in July.
Adoption Methods
The FASB has permitted an entity to apply one of the following transition approaches:
- A prospective approach: An entity would apply the amendments to new software costs incurred at the beginning of the adoption period.
- A modified transition approach: Based on the status of the project and whether software costs were capitalized before the date of adoption. The entity applies the new guidance prospectively to all software costs incurred after adoption. This includes costs for existing in-process projects. For any in-process project that was capitalized under the old guidance, but does not meet the new capitalization criteria at the time of adoption, the previously capitalized balance for that project is written off through a cumulative-effect adjustment to opening retained earnings as of the date of adoption.
- A retrospective transition approach: Entities should recast comparative periods and recognize a cumulative-effect adjustment to the opening balance of retained earnings as of the start of the first period presented.
Effective Date
ASU 2025-06 is effective for annual periods beginning after December 15, 2027, including interim periods within those years. Early adoption is permitted at the beginning of an annual period.
Potential Impacts
As this standard is tightening the criteria for capitalization, it is possible to see more costs expensed rather than capitalized. With more potential for upfront costs being recognized, the standard has the potential to put pressure on covenants especially those tied to EBITDA. Companies should model the impact of the standard early on in the process to understand how their key metrics will change. Proactive communication with lenders is critical to determine if covenant terms or definitions can be adjusted for accounting-driven changes.
Companies can reduce the risk of inconsistent or aggressive capitalization by establishing clear accounting policies aligned with ASU 2025-06 and applying them consistently. Additionally, strengthening internal controls, including a formal review and approval process, ensures costs are evaluated prior to capitalization.
How We See It
We see this shift in Internal-Use Software Capitalization as a valuable move from rigid, stage-based accounting toward a model that is driven by principles that better reflect how software is developed today. By tying capitalization to a “probable-to-complete” threshold, the guidance more accurately aligns with agile and iterative developments seen in industry today. In our view this both streamlines application in practice but also improves the consistency and transparency of the costs that are capitalized, which helps deliver business leaders more meaningful financial reporting.
Frequently Asked Questions (FAQs)
- When does ASU 2025-06 take effect?
It is generally effective for fiscal years beginning after December 15, 2027, including interim periods. Early adoption is permitted. - Does this apply to Cloud Computing (SaaS) arrangements?
Yes. The update specifically clarifies that costs incurred to implement a “service contract” (Cloud/SaaS) should follow this same capitalization model, ensuring consistency across on-premise and cloud software. - What costs are still expensed?
Costs in the “Preliminary Project Stage” (e.g., evaluating different vendors) and the “Post-Implementation Stage” (e.g., training employees, routine bug fixes, and maintenance) must still be expensed as incurred. - How does “Probable of Completion” differ from “Technological Feasibility”?
“Technological Feasibility” was a very high bar that required a working model or detail program design. “Probable of Completion” is a lower, more judgmental threshold based on management’s intent and ability to fund and finish the software. - Are there new disclosure requirements?
Yes. Companies must now provide a breakdown of capitalized software costs on the balance sheet and specify where software amortization is recorded on the income statement (e.g., within Cost of Goods Sold vs. R&D).
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The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.
