In 2016, eGames spent $8,000,000 developing new software. Of this amount, $5,300,000 was spent before July 2016—when technological feasibility was established. The product was marketed to consumers beginning in September 2016. eGames estimates total revenue of $20,000,000 to be earned during the software’s 3-year life (calculated from the September 1 product release date). During 2016, revenue of $10,000,000 was recognized.
Required:
- Prepare the 2016 journal entries to record the development costs.
- Compute the amount of amortization to be recognized in 2016 and prepare the appropriate journal entry, if any.
Prepare the necessary journal entries to record development costs incurred before July 1 and after July 1. Additional Instructions
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Prepare the necessary journal entries to record amortization on December 31.
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The Correct Answer and Explanation is :
To record the development costs and amortization for eGames in 2016, we need to distinguish between research and development costs before and after technological feasibility, as well as the amortization of capitalized software costs.
1. Journal Entries to Record Development Costs:
The development costs are split into two parts: before and after technological feasibility was established.
- Before July 1, 2016 (Research and Development Costs):
- Costs incurred before technological feasibility is established should be treated as research and development (R&D) expenses and recognized immediately as expenses.
- Amount spent before July 2016: $5,300,000.
Journal Entry for R&D Costs (before July 1, 2016):
Date Account Title Debit Credit
2016 Research and Development 5,300,000
Cash/Accounts Payable 5,300,000This entry reflects the $5,300,000 spent on research and development activities before the technological feasibility of the software was established.
- After July 1, 2016 (Capitalization of Development Costs):
- Once technological feasibility is established, software development costs that are directly related to creating the product can be capitalized.
- Amount spent after July 2016: $2,700,000 (Total development cost $8,000,000 – $5,300,000 R&D costs).
Journal Entry for Capitalized Development Costs (after July 1, 2016):
Date Account Title Debit Credit
2016 Software Development Costs 2,700,000
Cash/Accounts Payable 2,700,000This entry capitalizes the costs incurred after the technological feasibility date as part of the software asset.
2. Amortization for 2016:
The total expected revenue for the software over its 3-year life is $20,000,000, and revenue recognized in 2016 is $10,000,000. The amortization of the capitalized development costs is based on the revenue method, which is a percentage of revenue recognized in relation to total expected revenue.
Amortization Calculation:
- Total development cost to be amortized: $2,700,000 (capitalized costs after July 1, 2016).
- Revenue recognized in 2016: $10,000,000.
- Total expected revenue: $20,000,000.
The amortization for 2016 is calculated as:
[
\text{Amortization for 2016} = \frac{\text{Revenue recognized in 2016}}{\text{Total expected revenue}} \times \text{Capitalized costs}
= \frac{10,000,000}{20,000,000} \times 2,700,000 = 1,350,000
]
Journal Entry for Amortization in 2016:
Date Account Title Debit Credit
2016 Amortization Expense 1,350,000
Accumulated Amortization 1,350,000This entry recognizes the amortization of the capitalized software development costs for 2016, using the revenue-based method.
Explanation:
- Development Costs Before Technological Feasibility (R&D costs): These are expensed immediately under U.S. GAAP, as they are part of the research phase and do not meet the criteria for capitalization.
- Development Costs After Technological Feasibility (Capitalization): Once technological feasibility is established, costs directly associated with the development and design of the software product can be capitalized as an asset, and amortization will begin once the product is available for sale.
- Amortization Method: The software’s costs are amortized based on the ratio of revenue recognized during the year to the total expected revenue over the software’s life. This method ensures that the amortization expense reflects the revenue-generating capacity of the software.
By following these steps, eGames appropriately records and amortizes the software development costs in 2016.