A typical small business now pays a dozen or more software suppliers: accounting, email, file storage, design tools, a CRM, a password manager. Individually they are small; together they can rival the rent. Bookkeeping for them comes down to three questions, asked for each new supplier.
Question one: is it a service or an asset?
Software as a service (SaaS) gives you access to software that runs on the supplier’s systems for as long as you keep paying. You do not control the software itself, so the cost is an expense as you use it. Almost every cloud tool falls here, including set-up fees that cannot be separated from the service.
Software becomes an asset when the business acquires something it controls and will use over more than one year:
- a perpetual licence bought outright and installed on your own machines
- bespoke software built for you, where you own the result
- software developed in-house, if the development cost criteria are met
Under FRS 102, software that is integral to a piece of hardware (the operating system on a machine, for example) is treated as part of that tangible fixed asset. Other software you control is an intangible asset and is amortised over its useful life; see intangible assets. Costs of configuring or customising a SaaS product are usually expensed, because the business does not own the platform being configured. For software you build yourself, read research and development (R&D) tax credits for SMEs.
Question two: which period does the cost belong to?
Monthly plans are posted straight to the expense account. Annual plans paid up front need spreading.
An architects’ practice pays £1,800 plus £360 VAT on 1 October for a year of design software. Its year end is 31 December.
| Account | Debit | Credit |
|---|---|---|
| Prepayments | £1,800 | |
| VAT control account | £360 | |
| Bank | £2,160 |
Each month, £150 moves from prepayments to software subscriptions. At 31 December, £450 has been expensed and £1,350 remains as a prepayment on the balance sheet. A prepayment schedule listing every annual plan with its renewal date makes this quick to review; the balance sheet side is covered in supplier prepayments. For a usage-based tool billed after the event, the opposite applies: accrue the cost at month end.
Many businesses put very small annual plans straight to expense rather than spreading a £60 subscription over twelve months. That is reasonable if your materiality threshold is written down and applied consistently.
Question three: where is the supplier?
Many software suppliers are based outside the UK. When a UK VAT-registered business buys services from an overseas supplier, the supplier normally charges no UK VAT and the business applies the reverse charge: it accounts for the VAT itself as though it were the supplier.
A marketing firm receives an invoice for £500 from a US software company, with no VAT.
| Account | Debit | Credit |
|---|---|---|
| Software subscriptions | £500 | |
| Bank | £500 |
On the VAT return, £100 of output VAT goes in box 1 and the same £100 of input VAT goes in box 4, and £500 is added to both box 6 and box 7. For a fully taxable business the effect is nil, but leaving the entries out makes boxes 6 and 7 wrong, and a partly exempt business may not recover all of the input side. Set up a reverse charge VAT code in your software so this happens automatically. Some large overseas suppliers register for UK VAT and charge it on the invoice; then you reclaim it normally and no reverse charge applies. The full rule is in reverse charge VAT for services.
Invoices in dollars or euros are converted at the rate on the invoice date, or your software’s daily rate, and any difference on payment goes to exchange gains and losses.
Sub-accounts worth having
- Software subscriptions for business tools used across the company
- IT support and hosting, if you run servers or pay a managed service provider
- Software for resale or client projects, posted to cost of sales when it is consumed delivering client work
Avoid one account per supplier. A supplier report from the purchase ledger already gives that view, and it can be used to find tools nobody uses any more.
Tax treatment in brief
Subscription costs are normally a deductible business expense when incurred wholly and exclusively for the trade. Capitalised software is amortised in the accounts, and the tax relief then follows either the accounts or capital allowances depending on the asset; your accountant will make that call in the tax computation.
A quarterly look at the subscriptions account against card statements tends to pay for itself, because forgotten trials and duplicate seats show up quickly.