Jeremy Smith
By Jeremy Smith, CPA, MSA – Shareholder, Financial Institutions Group

Core system conversions can be one of the most-costly activities a financial institution undertakes. It’s a strategic decision that involves both cash expenditures and dedicated time from some of the organization’s most capable personnel.

Given the high level of organizational commitment involved, it is important to capture and capitalize all allowable costs. Capitalization will allow the institution to spread the cost over the useful life of the system rather than immediately taking the full impact against current year earnings, and ultimately capital.

Conversion Stages

The conversion process can be broken down into three stages.

  1. Preliminary Project Stage
  2. Application Development Stage
  3. Post Implementation

Preliminary Project Stage

As a rule of thumb, every activity before a new system is selected falls into the Preliminary Project Stage.  When a conversion is in the preliminary stage, entities will likely be doing the following:

  • Determine requirements of the system including internal or external surveys
  • Invite vendors to perform demonstrations of how their software will fulfill needs
  • Site visits to institutions utilizing systems under consideration
  • Evaluation and final selection of alternatives
  • Selection of consultants to assist in the process

Unfortunately, all costs incurred during the preliminary project phase must be expensed.

Application Development Stage

The Application Development Stage includes installing the software and any required hardware, coding, testing and anything else required to get the system ready for its intended use. Almost all costs in the development stage should be capitalized. The expenses to be capitalized include, but are not limited to:

  • Fees paid to third parties
  • Cost of software purchased from third parties
  • Payroll costs (salary and benefits) for employees to the extent of the time spent directly on the project. An employee’s time can be split. For example, if 50% of the employee’s time is spent on the project, then 50% of their cost can be capitalized. Examples of employee activities include, but are not limited to, coding and testing.
  • Travel expenses incurred by employees in their duties directly related to the conversion

However, any training costs for employees on the new system must be expensed.

Post Implementation and Operating Stage

Activities during the post implementation stage often include training of employees, data conversion and application maintenance and upgrades.

  • Training costs must be expensed in any phase
  • Costs to develop or obtain software that allows for access to, or conversion of, data by new systems should also be capitalized. However, all other data conversion costs should be expensed.
  • Maintaining the system results in current period expenses, but any upgrades or enhancements that result in increased functionality can be capitalized as outlined above

Conversion Accounting Guidelines

Capturing all capitalizable costs associated with a core data conversion can be a challenge, but the end result is the cost will be spread over the life of the system. Otherwise, recognizing the expenses at once will immediately reduce capital. Outlined below is the proper way to account for the various aspects of each conversion stage.

 

Pursuing a new core processor is a huge undertaking, but the value and growth potential your institution will see afterward will make it more than worth it. But, be sure to get the accounting for it right to avoid potential capital issues. If you have questions about how you should be accounting for your upcoming core software conversion, contact Doeren Mayhew’s Financial Institutions Group. They can help guide you through the process.