How Engineering and Product Managers Can Automate Software Development Cost Capitalization

How Engineering and Product Managers Can Automate Software Development Capitalization

Capitalization of software development costs is an accounting practice that allows companies to treat R&D costs as assets instead of expenses. In layperson’s terms: It helps spread some software development costs over time.

While capitalization is necessary for a company’s financial statements, it’s often administrative overhead for the people compiling the information: A combination of product managers, engineering managers, and finance pros.

If you hate doing your taxes once a year, you’ll sympathize with the team that prepares these reports every month or quarter. It’s tedious, time-consuming, error-prone, and unrewarding. And — if you’re reading this — you’re probably one of them.

But that's changing. Now that more and more engineering organizations are implementing software engineering intelligence platforms, a bulk of this gnarly work can be automated. For example, Faros AI draws all the necessary information from your systems of record, builds the downloadable cost capitalization report, and generates a dashboard for tracking and insights.

As a result, organizations benefit from automated, consistent, and auditable software capitalization reporting.

Read on to understand what cost capitalization is, how it’s been done manually for decades, and how the process is now getting blissfully automated.

What is software development capitalization?

Lauren Saunders has a storied career on the finance teams at Hubspot, Rapid 7, and Raytheon. At Hubspot, she supported the R&D organization as it scaled from 400 to over 1,000 engineers. That’s just one of the places she got to experience R&D capitalization up close.

Here’s how Lauren explains what R&D capitalization is:

“In our predominantly SaaS world, R&D cost capitalization syncs up the investment in R&D with the longer-term return in the form of recurring revenue,” Lauren explains. “Basically, it matches up the cost with the revenue stream. It syncs the timing of when a cost will hit the P&L to reflect accurate margins; instead of happening all at once, it happens over multiple periods.”

Instead of classifying specific software development costs as direct costs, software cost capitalization categorizes them as the cost of goods sold (COGS) over time. This classification has to be accurate, defensible, and auditable.

The challenge of manually preparing software capitalization reports

How companies typically prepare cost capitalization reports

The corporate accounting function is responsible for closing the books every month, quarter, and year. In partnership with an FP&A specialist who supports the engineering org, accounting will typically lead the exercise and interface with engineering and product managers to collect the information. They’ll also produce the supporting documentation to ultimately record the cost. Once the cost is recorded, the FP&A team will internally report results and insights.

Not every engineering activity is eligible for capitalization and only live features can be amortized. To prepare the documentation, two elements are collected, often in separate spreadsheets:

1. How much time was spent (per person/per activity) on eligible R&D activities
2. Which features were released into production

The intersection of those two elements represents what is capitalizable for the month. The accounting team needs to feel comfortable with the data they receive, so they can amortize the proper capitalizable items for accurate monthly financials.

Even with a well-structured spreadsheet and well-intentioned organization, if done manually, a lot of time and effort goes into this activity.

Why are time tracking and feature tracking so hard?

Since most companies don’t use time tracking systems, recording how much time was spent exclusively on capitalizable activities is a headache. Engineering and product managers spend many hellish hours digging into systems and speaking to people, all to fill in the spreadsheets that capture this information.

Once engineering leaders determine if something is capitalized, it is cross-referenced with feature launch status. Features can be classified as in development, beta, or production, which helps determine the useful life of the software. However, many organizations struggle to keep track of deployment status which complicates things.

Additionally, as companies scale, features aren’t necessarily released immediately to production. Some are scrapped and never released, creating further complications: “If you end up not wanting to release something and you scrap the feature, you actually have to take the cost at that moment of decision instead of spreading it over what was considered its ‘useful life’,” explains Lauren.

This is a lot to keep straight in spreadsheets…

“And with new people joining all the time, you find yourself constantly re-educating the team on how to do this properly,” says Lauren.

Automating software capitalization: How it works

“Every organization wants its R&D organization focused primarily on researching and developing new products,” says Lauren. Spending many hours each month on accounting activities is not ideal. “An automation tool that can support accurate financial data would be a significant and impactful investment for companies to consider.”

Automated cost capitalization reporting leverages the digital footprint left by engineering teams in the course of their daily work, like Jira, Azure DevOps, GitHub, GitLab, or Asana.

Engineers, designers, and product managers use several work and task management tools as part of their normal workflow. These tools generate timestamped data points that Faros AI leverages to calculate the time spent on eligible activities, following software capitalization rules. That includes starting new projects, completing tasks, submitting pull requests, and deploying to production.

By compiling and analyzing this information, Faros AI can construct a detailed picture of how time was allocated across different activities and create a report filtered to time spent on capitalizable work.

With just a few moments of configuration, you can have automated reporting that reflects the way your organization tracks R&D work (e.g., by initiative or epic) and translates effort to time (e.g., by story points, time in-progress or other).

The solution is flexible and intelligent enough to handle real-world complexities like overlapping tasks, poor data hygiene, and divergent workflows.

Here's how easy the setup is:

Key benefits of automating software development capitalization

Automating the process of capitalizing costs can provide several invaluable benefits for organizations, including:

• Save time and effort for your most highly-paid talent:
  Automating the R&D cost capitalization process significantly reduces the time and effort to produce the report. It allows your teams to focus their time and talent on value-adding work that helps implement corporate strategy, speeds up timelines, and accelerates innovation.
• Improve accuracy, transparency, and defensibility:
  Manual tracking and calculation is error-prone and inconsistent. Automating the process adds visibility and transparency while ensuring that the capitalization rules are applied correctly and consistently across projects. Additionally, automated systems provide clear audit trails and detailed reports on R&D costs, making it easier to track spending and understand the value of R&D investments while reducing the risk of non-compliance penalties or fines. 
• Repeatable and scalable:
  Finance teams can reduce the time they spend overseeing, monitoring, and re-educating members of the product and engineering organization. Automation provides a repeatable and scalable framework that supports a growing company. 

Automation means less distraction

By centralizing and standardizing software development cost capitalization data, automated solutions provide a robust foundation to effectively manage capitalization reporting.

This approach eliminates manual data collection, reduces errors, and offers a consistent methodology that can adapt to different organizational structures and workflows. The result is a more efficient, accurate, and less disruptive process for engineering teams and finance departments alike.

Getting started with Faros AI’s R&D Cost Capitalization module is easy. Request a demo today.