17 October 2021

Accounting for Agile Project Labor Costs

Accounting for Agile Project Labor Costs

  • In order to understand the capitalization of agile development expenditures, we should return to the definition of an “asset” and “capitalization,”.
  • The three stages of an IT project can be applied to agile as well as waterfall-developed software projects.
    • Accounting
      • An asset is defined as a potential future economic benefit that the firm controls based on past transactions.
      • To capitalize is to record an expenditure as an asset rather than to treat it as an expense of the current period.
    • The following describes the three different stages for an agile-developed project :
    • 1. The Preliminary Project Stage includes conceptual formulation, evaluation and final selection of alternatives.
      • Generally, once technical feasibility and the business case analysis are completed, the project is ready for consideration for funding approval by a company representative with budget authority.
      • After approval, the project team participates in a kick-off, or project inception, to deepen their understanding of WHAT the customer needs and to ensure that they will deliver an economic benefit to the organization with a high-level release plan.
      • All costs are expensed at this stage.
    • 2. In the Application Development Stage, the design of the chosen path, including software configurations and interfaces, marks the capitalization of project labor costs.
      • The team now moves from what to how.
      • All work associated with designing, developing, coding, testing and installing of hardware are valuable features for the customer that can be capitalized.
      • The customer may even be an internal department which will indirectly benefit the company’s net cash flows in the future.
      • One exception at this stage is administrative overhead, training and manual data conversion which should be expensed.
    • 3. The Post-Implementation / Operation Stage begins after the code is in production and after final customer acceptance, testing and stabilization are completed.
      • Typical activities in this stage include training, bug-fixing and maintenance.
      • The costs at this stage are expensed.

Comparison of Phases Waterfall versus Agile Software Development Methods

  • Waterfall project
    • Methodology / Phase :
      • Preliminary (Expensed)
        • All customer requirements are documented, analyzed and determined technically feasible.
        • Business case has merit.
        • Financial resources are authorized by a company representative with budget authority.
        • High level customer requirements are determined technically feasible.
      • Development : (Capitalized, except administrative overhead costs)
        • Design, coding and testing.
        • Customer is not engaged.
        • Projects are linear.
      • Post-Implementation / Operation (Expensed)
        • Customer accepts or rejects the project in the final approval stage.
  • Agile project
    • Methodology / Phase :
      • Preliminary (Expensed)
        • High level customer requirements are determined technically feasible.
        • Business case has merit.
        • Financial resources are authorized by a company representative with budget authority.
      • Development : (Capitalized, except administrative overhead costs)
        • Design, coding, testing: requirements prioritized for the next iteration with feedback from the customer.
        • Customer highly engaged throughout.
        • Projects have multiple iterations, and each may re-prioritize the requirements.
      • Post-Implementation / Operation (Expensed)
        • Customer has accepted each iteration throughout the project, eliminating the risk of rejection in the final approval stage.
        • Capitalizing software development expenditures
        • The impact of appropriately capitalizing software development expenditures can be significant, and has a number of important benefits.
        • Conservative treatment of agile projects -expensing all costs- limits the use and extent of agile- developed software projects.
        • Software development resources are expensive and often limited.
        • Appropriate capital allocation of these resources is important to the competitive health of the company, and also ensures consistent reporting and capital allocation within management and across organizations for investors.

For more information about the Software Development Lifecycle, please review:
http://en.wikipedia.org/wiki/Systems_development_life-cycle#Complementary_to_SDLC

For more information about Waterfall SDLC please review methodology:
http://en.wikipedia.org/wiki/Waterfall_model

For more information about Agile Methods and SDLC, please review:
http://en.wikipedia.org/wiki/Agile_software_development

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