Should software upgrades be capitalized?

Software upgrades should be capitalized only if they improve functionality, which means they enhance the software’s capabilities or extend its useful life beyond what was originally intended. This includes improvements such as adding new features, increasing performance, or extending compatibility with other systems.

When an upgrade merely maintains the existing functionality or addresses minor bugs, it is typically considered an operating expense and, therefore, should not be capitalized. This distinction is crucial for proper accounting practices, as capitalizing only those upgrades that enhance functionality aligns with accounting standards. Under these standards, expenditures that provide future benefits are capitalized, while routine maintenance or minor upgrades are expensed.

Considering the cost of upgrades is not the sole determining factor for capitalization; it is the impact on functionality that dictates accounting treatment. Therefore, any assessment of whether software upgrades should be capitalized must focus on how they enhance or alter the software's capabilities.