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Software is the general term describing programmes of instructions, languages and routines
or procedures that make it possible for an individual to use the computer. It is any prepared
set of instructions that controls the operations of the computer for computation and process-
ing. More specifically, the term software applies to those programmes that are built within
the computer. These programmes forming the software are supplied by the manufacturers
and are usually named as packages. The hardware, the electronic, electrical, magnetic and
mechanical components or devices that make the computer and software taken together
form a computer system. It must be remembered that even a very powerful computer is
useless junk without a strong support from its software.
In case computer software is acquired for sale in the ordinary course of business, it is treated
as inventory and AS-2, Valuation of Inventories, is applicable which has been discussed in
Section I of the book. If it is meant for internal use, AS-26 is applicable.
Computer software for internal use can be either:
(i) acquired, or
(ii) internally generated.


The cost of a software acquired for internal use should be recognized as an asset if it meets
the recognition criteria prescribed in paragraphs 20 and 21 of the Accounting Standard-26*
of the Institute of Chartered Accountants of India which are given below:
“19. The recognition of an item as an intangible asset requires an enterprise to demonstrate
that the item meets the following definition and criteria:
(a) Definition of an intangible asset
An intangible asset is an identifiable non-monetary asset, without physical substance, held
for use in the production or supply of goods or services, for rental to others, or for adminis-
trative purposes.
An asset is a resource:
(a) Controlled by an enterprise as a result of past events: and from which future economic
benefits are expected to flow to the enterprise.
Non-monetary assets are assets other than monetary assets. Monetary assets are money
held and assets to be received in fixed or determinable amounts of money.
(b) Recognition criteria set out in this Statement.

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“20. An intangible asset should be recognized if, and only if:

(a) It is probable that the future economic benefits that are attributable to the asset will flow
to the enterprise; and
(b) The cost of the asset can be measured reliably.
*AS-26 applies in case of 10 enterprises whose securities are listed on an Indian recognized
stock exchange and (ii) other business enterprises having annual sales exceeding Rs. 50 crores.
AS-26 is mandatory for accounting periods beginning on or after 1-4-2003.
21. An enterprise should assess the probability of future economic benefits using reasonable
and supportable assumptions that represent best estimate of the set of economic condi-
tions that will exist over the useful life of the asset.
22. An enterprise uses judgment to assess the degree of certainty attached to the flow of
future economic benefits that are attributable to the use of the asset on the basis of the
evidence available at the time of initial recognition giving greater weight to external
23. An intangible asset should be measured initially at cost. In the determination of cost,
matters stated in following paragraphs of Accounting Standard-26 are to be consid-
24. If an intangible asset is acquired separately, the cost of the intangible asset can usually
be measured reliably. This is particularly so when the purchase consideration is in the
form of cash or other monetary assets.
25. The cost of an intangible asset comprises its purchase price, including any import duties
and other taxes (other than those subsequently recoverable by the enterprise from the
taxing authorities), and any directly attributable expenditure on making the asset ready
for its intended use. Directly attributable expenditure includes, for example, professional
fees for legal services. Any trade discounts and rebates are deducted in arriving at the
26. If an intangible asset is acquired in exchange for shares or other securities of the report-
ing enterprise, the asset is recorded at its fair value. or the fair value of the securities
issued whichever is more clearly evident.


Internally generated computer software for internal use is developed or modified internally
by the enterprise solely to meet the needs of the enterprise and at no stage it is planned to sell
The stages of development of internally generated software may be categorized into the
following two phases:
a. Preliminary project stage. i.e., the research phase.

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b. Development stage.
a. Preliminary project stage, i.e., the research phase
At the preliminary project stage the internally generated software should not be recognized
as an asset. Expenditure incurred in the preliminary project stage should be recognized as an
expense when it is incurred. The reason for such a treatment is that at this stage of the
software project an enterprise cannot demonstrate that an asset exists from which future
economic benefits are probable.
When a computer software project is in the preliminary project stage enterprises are likely
a. Make strategic decisions to allocate resources between alternative projects at a given
point in time. For example, should programmers develop a new Accounts system or
make efforts toward correcting existing problems in an operating Accounts system.
b. Determine the performance requirements as well as the systems requirements for the
computer software project it has proposed to undertake.
c. Explore alternative means e.g. should an entity make or buy the software. Should the
software run on a mainframe or a client server system?
d. Determine that the technology needed to achieve the same.
e. Study the requirement of a consultant to assist in the development and/or installation
of the software.
b. Development stage
Internally generated software arising at the development stage should be recognized as an
asset if, and only if, an enterprise can find out all of the following:
(b) The intention of the enterprise to complete the internally generated software and use it
to perform the functions needed. For example, the intention to complete the internally
generated software can be demonstrated if the enterprise commits to the funding of the
software project;
(a) The technical feasibility of installing the internally generated software.
(c) The ability of the enterprise to use the software;
(d) The probable usefulness of and economic benefits from the software.
(e) The availability of adequate technical, financial and other resources to com
plete the development and to use the software; and
(f) The capacity to measure the expenditure attributable to the software during its

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Examples of development activities in respect of internally generated software include:

Detailed programme design of for the software considering product function, feature, and
technical requirements to their most detailed, logical form and is ready for coding.
Codification of requirements. The coding of computer software may begin prior to, concur-
rent with, or subsequent to the completion of the detailed programme design.
At the end of these stages of the development activity, the enterprise has a working ‘model,
which is an operative version of the computer software capable of performing all the major
planned functions, and is ready for initial testing (“beta” versions).
Testing which is the process of performing the steps necessary to determine whether the
developed software meets the targeted performance requirements.
At the end of the testing process, the enterprise has a master version of the internal use of
software, which is a completed version together with the related user documentation and
the training materials.
Cost of internally generated software
The cost of internally generated software is the sum of the expenditure incurred from the
time when the software first met the recognition criteria for an intangible asset as stated in
paragraphs 20 and 21 of AS-26 given earlier. An expenditure which did not meet the recog-
nition criteria as aforesaid and expensed in an earlier financial statements should not be
reinstated if the recognition criteria are met later.
The cost of internally generated software comprises all expenditure that can be directly at-
tributed or allocated on a reasonable and consistent basis to create the software for its in-
tended use. The cost includes:
(a) Expenditure on materials and services used or consumed in developing the software;
(b) The salaries wages and other employment related costs of personnel directly engaged in
developing the software;
(c) Any expenditure that is directly attributable to generating software;
(d) Overheads related to developing the software and that can be allocated on a reasonable
and consistent basis to the software (for example. an allocation of the depreciation of
fixed assets, insurance premium and rent). Allocation of overheads is made on the nor-
mal acceptable basis.
The following are not components of the cost of internally generated software:

1. Selling, administration and other general overhead expenditure unless this expenditure
can be directly attributable to the development of the software;
2. Clearly identified inefficiencies and initial operating losses incurred before software
achieves the planned performance; and

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3. Expenditure on training of the staff to use the internally generated software.
Subsequent expenditure
Considerable cost may have to incur in modifying existing software systems. Subsequent
expenditure on software after its purchase or its completion should be recognized as an
expense when it is incurred unless:
(a) It is probable that the expenditure will enable the software to generate future economic
benefits in excess of its originally assessed standards of performance; and
(b) The expenditure can be measured and attributed to the software reliably. If these condi-
tions are met, the subsequent expenditure should be added to the carrying amount of
the software. Costs incurred in order to restore or maintain the future economic benefits
that an enterprise can expect from the originally assessed standard of performance of
existing software systems is recognized as an expense when, and only when, the resto-
ration or maintenance work is carried out.
Period of Amortization
The depreciable amount of a software should be allocated on a systematic basis over the best
estimate of its useful life. The amortization should commence when the software is available
for use.
As per AS-26, there is a presumption that the useful life of an intangible asset will not exceed
ten years from the date when the asset is available for use. However, due to phenomenal
changes in technology, computer software is susceptible to technological obsolescence. There-
fore, it is better to consider the useful life of the software much shorter, say 3 to 5 years.
Method of Amortization
The amortization method used should reflect the pattern in which the software’s economic
benefits are consumed by the enterprise. If that pattern cannot be determined reliably, the
straight-line method should be used.
The amortization charge for each period should be recognized as expenditure unless an-
other Accounting Standard permits or requires it to be included in the carrying amount of
another asset. For example, the amortization of software used in a production process is
included in the carrying amount of inventories.
The financial statements should disclose the following for computer software, distinguishing
between internally generated software and acquired software:
(a) The useful lives or the amortization rates used;
(b) The amortization methods used;
(c) The gross carrying amount and the accumulated amortization at the beginning and end
of the period;

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(d) A reconciliation of the carrying amount at the beginning and end of the period show-
(i) additions;
(ii) retirements and disposals;
(iii) impairment losses;
(iv) amortisation recognised during the period; and
(v) other changes in the carrying amount during the period.
Case Study- XXX limited

The company is organized into two main business segments:

- Learning Solutions Business comprising of provision of education and training to indi-
viduals, government and corporate clients primarily in the field of information technology.
- Software Solutions Business comprising of software services, systems integration and prod-
uct distribution.
Segment Information for the year ended 31st March 2007
Primary Segment Information-Business Segment

(Million Rs)
Learning Solutions Software Solutions Total

25,641 19,356 44,997
External Sales
Segmental Results 5,009 2,851 7,860
Unallocated Corporate

Statement on Significant Accounting Policies.

The financial statements are prepared on an accrual basis and under historical cost conven-
tion. The significant accounting policies adopted by the company regarding Fixed Assets,
Depreciation and Research and Development are detailed below:
Fixed Assets and Depreciation
Fixed Assets are stated at acquisition cost.
Depreciation is charged on a pro-rata basis on the straight-line method. over the estimated
useful lives of the assets determined as follows:

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3 years or lease period whichever is
Leasehold Improvements
Courseware products developed and capitalised 1-3 years
Desktops/low configuration workstations, related
2-3 years
accessories and software

File servers, high ended workstations/servers,

networking equipment, related accessories
and software 4-5 years
Library books 3 years
Assets under employee benefits scheme 3 years
Rates prescribed under schedule
All other assets
XIV to Companies Act, 1956.

Further, computer systems and software forming part of plant and machinery are techni-
cally evaluated each year for their useful economic life and the unamortised depreciable
amount of the asset is charged to profit and loss account as depreciation over their revised
remaining useful life.
Research & Development
Equipment purchased by the Company for research and development purposes are capital-
ized in the year of acquisition and included in Fixed Assets. All revenue expenses incurred
for research and development activities are charged to the profit and loss account for the
Expenditure incurred on Research & Development
2007 2006
Capital purchases 726,630 20,256,233
Revenue expenditure 19,145,152 96,699,335

1. State whether the following statements are true or false:

(1) AS-26 applies when computer software is acquired for sale in the ordinary course of
(2) Coding is part of preliminary stage.
(3) Costs incurred in salaries/wages in internally generated software are included in the
cost computation.
Ans: (1) F (2) F (3) F

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2. Choose the correct answer

(1) The amortization of amount of software commences from the date when it is
(a) available for use (h) put to use (c) developed upto 75%
(2) There is a rebuttable assumption that the useful life of an intangible asset like Computer
Software will not exceed
(a) 5 years (b) 10 years (c) 15 years
Ans: (1) a (2) b

(1) Discuss the position of AS-26 on the treatment of Software acquired for internal use.
(2) Explain the treatment of internally generated software (a) in the preliminary stage and
(b) in the development stage as per AS-26.
(3) Explain the amortization requirements w.r.t. period and method in respect of computer
software as per AS-26.
1. An enterprise is developing as software internally. In the year 2006, expenditure in-
curred was Rs. 25 lacs, of which Rs. 24 lacs was incurred before 1st December 2006. The
enterprise was able to demonstrate on 1 st December 2006 that the software develop-
ment met the criteria for being recognized an intangible asset. The recoverable amount
of the know-how embodied in the development (including future cash outflows to com-
plete the process before it is available for use) is estimated to be Rs 20 lacs. How will you
treat it in Financial Accounts and disclose it in the Balance Sheet of the company?
2. A computer software is appearing in Balance Sheet of A Ltd. on 1.04.05 at Rs. 8 lakhs. It
was acquired for Rs. 20 lakhs on 1.4.2002, available for use from then. It follows a policy
of amortizing the item over 5 years straight line. The period as per AS-26 is 8 years. How
much amount should be amortised over the next two years?

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