Engineering salaries are often the largest line in a SaaS company's P&L. Under GAAP, some of that spend is not an expense at all: it builds an asset. Capitalizing it correctly changes reported operating loss, EBITDA and the balance sheet, so investors and auditors look at the policy closely.
Which standard applies
A SaaS product that customers use over the internet without taking a copy of the software is generally internal-use software under ASC 350-40, even though it produces revenue. ASC 985-20 applies to software sold, licensed or marketed for customers to install.
The current model: three stages
| Stage | Examples | Treatment |
|---|---|---|
| Preliminary project | Evaluating alternatives, defining requirements, proof of concept | Expense |
| Application development | Design, coding, testing, installing, building new features that add functionality | Capitalize qualifying costs |
| Post-implementation and operation | Training, maintenance, bug fixes, data conversion (mostly) | Expense |
Qualifying costs include payroll and benefits of employees working directly on the project, contractor costs and certain interest. General overhead and administrative costs are expensed.
What ASU 2025-06 changes
The FASB issued ASU 2025-06 in September 2025. It removes the references to development stages. Capitalization begins when management has authorized and committed to funding the software and it is probable the project will be completed and the software used as intended, considering whether significant development uncertainty remains (for example, novel or unproven functionality). The update is effective for annual periods beginning after December 15, 2027, with early adoption permitted. Companies building their policy now should write it with the new threshold in mind.
A worked example
A team of six engineers, average loaded cost $18,000 a month each, spends a quarter building a new reporting module that adds functionality. Time tracking shows 70% on the module and 30% on maintenance and bug fixes.
| Item | Amount |
|---|---|
| Total quarterly engineering cost | $324,000 |
| Capitalized (70% on qualifying work) | $226,800 |
| Expensed (maintenance, fixes) | $97,200 |
Once the module is ready for use, the $226,800 is amortized straight-line over its useful life, often three years: $6,300 a month, recorded in cost of revenue or R&D according to the company's policy.
Documentation auditors ask for
- A written capitalization policy, including the minimum project size
- Project records showing authorization and the date the feature went live
- Time allocation by engineer and project, from a ticketing or time system
- An impairment review when a capitalized feature is abandoned
The tax side is different
For federal income tax, software development costs are research or experimental expenditures under Section 174. For tax years beginning after December 31, 2024, domestic research expenditures can be deducted currently under Section 174A, while foreign research is amortized over 15 years. The book asset and the tax deduction move on different schedules, which creates a deferred tax difference.
We write the policy with your engineering leads, pull the time data each month, and book the capitalization and amortization at close.
Sources
- FASB Accounting Standards Codification, Subtopic 350-40, Internal-Use Software (and ASU 2025-06)
- IRS, Instructions for Form 6765
Questions founders ask
Does a SaaS platform fall under ASC 350-40 or ASC 985-20?
Software that customers access as a hosted service without taking possession is generally internal-use software under ASC 350-40. ASC 985-20 covers software to be sold, leased or otherwise marketed.
Is capitalization required?
When the criteria are met, qualifying costs are capitalized under GAAP. Small amounts may fall under a company's capitalization threshold, and early-stage companies often find few costs qualify, but the policy should be written and applied.
