Development costs incurred in the development of software help in the production of revenues across multiple time periods. As a result, software development costs are recorded as an asset in a process called capitalized expenditure. Capitalized expenditures are subject to amortization, a process in which their values are written off over time in order to reflect their usage in the production of revenue.
In accrual basis accounting, the Matching Principle requires that accountants record costs in the same time period as the revenues that their occurrence helped produce. This is done to avoid distortions where enormous revenues or expenses are recorded in single periods when the process of earning or incurring them happened over multiple periods. Both depreciation and amortization are done in order to comply with the Matching Principle.
Amortization is similar to the process of depreciation, though amortization is applicable only to intangible assets without material existence. Both depreciation and amortization are intended to distribute costs across multiple time periods in order to better reflect their occurrence across time, rather than at one single point in time.
Software development costs can be recorded as capitalized expenditures, which are expenses that have become assets. Expenses are capitalized if their occurrence helps produce revenues in more than the period in which they are incurred. For example, since software developed for sale will be sold in more periods than the ones in which development costs were incurred, said costs should be capitalized and written off in those subsequent periods to better reflect reality.
Amortization of Developed Software
Amortization of capitalized software development costs is done in much the same manner as depreciation. First, the amount to be amortized is the asset's total value minus its estimated residual value, which can be none in this case. The amortization expense for each period is the amount to be amortized divided over the number of periods in which the capitalized expenditure will continue to be of use.