Capitalised Development Costs: The Evidence Auditors Will Ask For
Capitalising software and product development flatters EBITDA, which is why auditors challenge it hard. How to build a defensible position from day one.
For technology and product led businesses, capitalising development spend can move EBITDA materially. That is exactly why it attracts attention from auditors, buyers and lenders alike.
Under both IAS 38 and FRS 102, development costs can only be capitalised once specific criteria are met. The accounting choice is not the hard part. Producing contemporaneous evidence that the criteria were met is.
The criteria in plain terms
You need to show the project is technically feasible, that you intend to complete and use or sell it, that you have the resources to do so, that it will generate future economic benefit, and that you can measure the costs reliably. Research phase costs must be expensed.
Each of these needs documentation dated at the time, not reconstructed at year end when the auditor asks.
Time recording is the weak point
Most capitalised cost is staff time. If engineers do not record time against projects, the business ends up estimating percentages after the event. Auditors treat those estimates with suspicion, and rightly so.
A lightweight approach works: project codes in the existing ticketing or timesheet tool, a monthly summary signed by the engineering lead, and a reconciliation to payroll.
Separate maintenance from development
Bug fixes, routine updates and support are not development. A clear project register showing which work creates new functionality and which maintains existing products helps you draw the line consistently.
Impairment and amortisation
Once a project goes live, amortisation starts. Agree a useful life you can justify and review capitalised balances for impairment each year, particularly for products that have been paused or replaced.
Why this matters at exit
Buyers performing quality of earnings work routinely adjust EBITDA for aggressive capitalisation. A clear, consistently applied policy with evidence behind it protects valuation and avoids a difficult conversation late in a sale process.