Accounting Standards

Costs of Modifying Existing Software

Paragraph 11 of FRS 1, Presentation of Financial Statements, requires that financial statements should not be described as complying with Financial Reporting Standards unless they comply with all the requirements of each applicable Standard and each applicable Interpretation of the Financial Reporting Standard. INT FRSs are not intended to apply to immaterial items.

Reference: FRS Framework for the Preparation and Presentation of Financial
Statements

1. Enterprises may incur considerable costs in modifying existing software systems. For example, such costs may be incurred to enable them to continue to operate as intended after the turn of the millennium (often referred to as "software 2000 costs") or after the introduction of a new currency (e.g., the "euro").
   
   
2. The issues are:
   
   1. whether such costs may be capitalised; and if not,
      
      
   2. when such costs should be recognised as an expense.



3. This Interpretation does not address
   

   1. the costs of modifying software produced for sale,
      
      
   2. purchases of replacement software,
      
      
   3. enhancements of the system ("upgrading") beyond those necessary to enable the systems to continue to perform as anticipated, and
      
      
   4. the recognition of impairment losses related to existing computer software.

In accordance with paragraphs 85 and 86 of the FRS Framework (and applying the rationale of FRS 16.23 to 27 by analogy), subsequent costs for modifying existing software systems should be recognised as an expense when they are incurred unless

1. it is probable that those costs will enable the software to generate specifically attributable future economic benefits in excess of its originally assessed standard of performance and
   
   
2. those costs can be measured and attributed to the asset reliably. The conditions for capitalisation are not met for costs incurred in order to enable existing software systems to operate as originally intended after the turn of the millennium or after the introduction of the euro.

In accordance with paragraph 87 of the Framework, a liability is recognised in the balance sheet when

1. it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and
   
   
2. the amount at which the settlement will take place can be measured reliably. A liability is not recognised if expenditure relates to benefits that have yet to be received. The fact that the expenditure may be necessary for the enterprise to continue in business does not create a legal or constructive obligation towards an external party. A liability is, therefore, recognised only as the work related to the modification of existing software is performed by third parties. It is not appropriate to recognise such costs as provisions or other liabilities before the work is carried out based, for example, on commitments made or contracts entered into with third parties.

Effective Date: INT FRS 6 comes into effect on 1 February 2003. Changes in accounting policies should be accounted for according to the transitional requirements in FRS 8.40