In this paper, we evaluate accounting practices for internal‐use software expenditures. Statement of Position No. 98‐1 (SOP No. 98‐1) requires expensing certain costs and capitalizing others. We argue that current accounting practice does not allow enough capitalization, since costs incurred during the systems analysis stage of model‐based systems development are expensed regardless of whether they create future benefits. The quest for uniformity in accounting treatment in the form of a single rule for multiple economic phenomena (i.e., treating all systems acquisition and development methods the same) results in reduced ability to reflect economic differences between systems acquisition and development methods. To illustrate, we provide an example of the differential effects of adopting SOP No. 98‐1 for firms using different development approaches. Under the SOP, “Analysis” costs are expensed. Under model‐based approaches, especially those with downstream effects, these Analysis costs are assets, since the reason for these approaches is their ability to re‐use models and objects developed in Analysis. Furthermore, since these costs tend to be relatively higher for companies leveraging these models and objects, the SOP has the effect of ignoring the future value associated with these models and objects. We propose a solution that is principles‐based and provides a framework specifying the conditions under which capitalization or expensing should occur for internally developed software.

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