What is capitalized software in accounting?

Under US GAAP (ASC 350-40), software developed or purchased for internal use can be capitalized during the "application development stage." This typically includes the cost of coding, testing, and configuration. Preliminary planning costs and post-implementation maintenance costs must be expensed.

The three-stage framework matters: preliminary project stage costs (researching options, evaluating alternatives) must be expensed. Application development stage costs (coding, testing, data conversion) may be capitalized. Post-implementation stage costs (training, maintenance, bug fixes) must be expensed. Getting these distinctions right is important when the amounts are material.

Once capitalized, software is amortized over its expected useful life - typically 3–5 years. Each year, a portion of the cost is recorded as amortization expense. This smooths out the financial impact of large software purchases.

For a $60,000 software implementation capitalized over 3 years, you record $20,000 of amortization expense per year rather than the full $60,000 in year one. This matching principle - spreading the cost over the period the software provides benefit - gives a more accurate picture of annual profitability and is required under both US GAAP and IFRS.

In Note.now, capitalize software by creating a Fixed Asset account in your chart of accounts (e.g., "Capitalized Software"). Record the purchase as a debit to that account. Set up a depreciation schedule and post monthly amortization journal entries. Your accountant can help you determine what qualifies for capitalization.

For SaaS subscriptions - monthly or annual fees for cloud-based tools - capitalization generally does not apply. These are expensed as incurred because you do not own a perpetual license to the software. The capitalization question arises when you commission custom software development or purchase a perpetual on-premise license.