Understanding ASU 2025-06: What It Means for Internal-Use Software Accounting

In September 2025, FASB issued ASU 2025-06, modernizing accounting for internal-use software costs under ASC 350-40. This update aligns guidance with today's agile development realities.

Why the Update Was Needed

Outdated accounting rules for internal-use software, designed for traditional, on-premise waterfall projects, struggled to keep pace with modern technology like cloud computing and agile development. This created significant ambiguity and complexity. ASU 2025-06 delivers clearer, more flexible guidelines, reflecting current software development realities and improving financial reporting comparability.

Detailed Comparison: Old Stage-Based vs. New Criteria-Based Approach

The Previous Stage-Based Approach (ASC 350-40)

Historically, ASC 350-40 mandated a three-stage approach for internal-use software development, mirroring a waterfall model. Costs were categorized by distinct phases:

• Preliminary Project Stage: Costs for evaluating alternatives, determining requirements, and vendor selection were typically expensed as incurred. This covered activities before committing to a specific software project.

• Application Development Stage: Once management committed to and authorized a project, certain costs could be capitalized. This included coding, interface design, installation, and testing. Capitalization ceased when the software was ready for its intended use.

• Post-implementation Stage: All costs after the software was substantially complete, such as training, maintenance, and minor enhancements, were again expensed as incurred.

This framework assumed sequential development. However, modern agile practices—where design, development, and testing occur concurrently and iteratively made these distinct stages difficult and subjective, leading to inconsistent cost allocation.

The New Criteria-Based Approach (ASU 2025-06)

ASU 2025-06 addresses these challenges by replacing the rigid stage-based model with a principles-based approach. It introduces two key capitalization criteria, better suited for modern, incremental development cycles like agile methodologies and cloud environments. This shift reduces complexity in cost categorization and clarifies capitalization decisions.

Management Authorization

Projects must be explicitly authorized and funded by management before costs can be capitalized. This ensures clear intent and commitment, providing a tangible trigger for capitalization, and demonstrating an expectation of future economic benefits.

Probable-to-Complete

It must be probable the software will be completed and used for its intended purpose. This criterion emphasizes the feasibility and expected future benefit, requiring high certainty of successful deployment and utility. It focuses on project viability, not just progress within a predefined stage.

This principles-based approach offers flexibility for incremental development, allowing companies to capitalize costs once both criteria are met, often earlier than under the old guidance.

Consolidation of Website Development Guidance

Previously, website development costs had separate, often inconsistent, guidance. ASU 2025-06 explicitly consolidates website development guidance into ASC 350-40. Now, costs for developing any website—internal or external will follow the same two.
capitalization criteria: management authorization and probable-to-complete. This brings clarity and uniformity, simplifying accounting for companies with a significant web presence.

Detailed Disclosure Requirements

To enhance transparency, ASU 2025-06 expands disclosure requirements for internal-use software costs. Companies must provide more robust information in financial statements, including:

• Capitalized internal-use software costs for the period, distinguishing external vs. internal costs.

• The amortization method and period for capitalized internal-use software.

• A roll forward of the carrying amount, including additions, amortization, and impairments.

• The entity's accounting policy for internal-use software, specifying capitalization start and stop points.

• The nature of projects where internal-use software costs were capitalized, with qualitative descriptions of significant projects.

• Significant judgments made in applying capitalization criteria, particularly regarding management authorization and probability of completion and use.

These enhanced disclosures offer users better insights into capitalized software costs, related policies, and management judgments, improving comparability and decision-making.

Transition Methods and Effective Dates

ASU 2025-06 is effective for annual periods beginning after December 15, 2027, including interim periods. Early adoption is permitted.

Companies have three primary transition methods:

• Modified Retrospective Approach: Apply new guidance to costs incurred in fiscal years starting after December 15, 2027. Record the cumulative effect as an adjustment to opening retained earnings in the adoption period. This provides some comparability without full restatement.

• Prospective Approach: Apply new guidance only to costs incurred after the adoption date. Simpler to implement as it avoids prior financial statement adjustments, but offers less comparability between periods during transition.

• Full Retrospective Approach (optional): Apply new guidance retrospectively to all prior periods presented. Requires restatement of all affected prior financial statements, offering the highest comparability but also the most complexity and cost.

Impact Across Industries

The impact of ASU 2025-06 will vary by industry, depending on their investment in internal-use software:

• Technology and SaaS Companies: Engaged in continuous, agile development. New guidance may allow earlier capitalization, potentially affecting asset levels and profitability metrics. The criteria-based approach should simplify accounting compared to forcing agile into a waterfall model.

• Financial Services: Heavily invest in internal software (e.g., trading platforms, risk management). The update requires reviewing existing capitalization policies and adjusting project accounting and internal controls.

• Manufacturing and Retail: Developing custom ERP systems, supply chain software, or e-commerce platforms will need to adapt. Consolidated website development guidance is particularly relevant for retailers with significant online operations.

• Healthcare: Providers and insurers developing internal EHR systems, patient management tools, or compliance software must align capitalization practices with the new criteria.

Implications for Financial Reporting

Businesses must proactively adapt to ASU 2025-06. This includes reviewing existing internal policies, training accounting and project management teams, and updating internal control frameworks to support new documentation and judgment requirements. Organizations with significant internal-use software development should assess the potential impact on financial statements, particularly capitalized costs and depreciation schedules. The chosen transition method will also affect comparability and operational implementation. These changes aim to deliver more accurate and relevant financial reporting for modern software development activities.