The Rise of E-Commerce
The growth of e-commerce has completely transformed the retail industry in recent years. The ease of online shopping has made it a preferred method for many consumers, and businesses capitalized on this trend. The covid pandemic has likewise accelerated the industry’s growth. With lockdowns and restrictions implemented in many countries, consumers patronized online shopping as a safer and more convenient option to purchasing goods. There was also a rise on online payment and delivery services. As a result, entrepreneurs and small businesses are attracted to building their e-commerce websites seeing the potential for increased revenues and a broader market.
However, while creating an e-commerce website is an exciting prospect, it is essential to consider the accounting treatment of a web design and development costs. When a business creates an e-commerce website, it will incur costs for various activities such as planning, website application and infrastructure development, graphics development, content development, and operating expenses. The accounting treatment of these costs depends on the stage of development.
Guide to Accounting Treatment
A website can be capitalized as an intangible asset if the company can justify that the website will generate probable future economic benefits.
For accounting purposes, website development is explained to have five stages.
- Planning Stage. Planning includes all costs before actual website development, such as expenses incurred in initiating the plan, identifying specific goals, determining the timetable, setting the budget, and deciding who will be doing the project internally, hiring freelancers, or engaging a software developer – among others. All costs at this stage will be recorded as an expense.
- Website Application and Infrastructure Development Stage. This stage covers activities to acquire or develop software and hardware needed to run the website, secure the domain name and create HTML pages, among others. This may also include compensation/benefits for programmers, software developers, or other employees working on the project, consulting fees, and software testing. These costs will be capitalized.
- Graphics Development Stage. This stage encompasses the website’s design, layout, images, color, and look, which will not change when there are content updates. The costs incurred for the initial graphics should be capitalized. Subsequent updates should be booked as an expense unless they will provide additional functionality over multiple periods.
- Content Development Stage. This stage starts after the website layout has been designed. It provides information on the website through articles, photos, or charts. Generally, the cost is treated as an expense.
- Operating Stage. This is the last stage, wherein the website is fully designed and operational. It will cover the website’s administration, maintenance, training, and other costs. These costs should be expensed unless there are substantial upgrades that may need further assessment if they are to be capitalized.
Unlike tangible assets such as plant, property, and equipment, which are depreciated over time as these go through wear and tear, web design and development cost as an intangible asset is subject to amortization over its useful life as this may go outdated over time.
The method of amortization used should follow the revenues generated. The typical method recommended is the straight-line basis.
Below is a table presenting the comparative details:
As the website is evaluated to have a useful life of 3 years, those items that are capitalized (website application and infrastructure development, graphics development stage) are amortized over 3 years. Hence, while the total cost is 12,000 €, only 6,000 € will be charged as expense for the year.
Benefits and Challenges
Like any other business decision, one must weigh the opportunities and challenges of building an e-commerce website before committing to financing this project.
Benefits of an e-commerce website:
- Global Reach: E-commerce websites have a global reach and allow businesses to sell their products and services to customers worldwide, regardless of location. This opens up new markets for companies that physical storefronts may have previously limited.
- Lower Overhead: E-commerce businesses typically have lower overhead costs than traditional brick-and-mortar stores because they don’t need to pay for rent, utilities, or other expenses associated with a physical storefront.
- Increased Convenience: E-commerce websites offer customers the convenience of shopping from anywhere, at any time. Customers can browse and purchase products from their homes without traveling to a physical store. This is particularly appealing to busy consumers.
- Lower Marketing Costs: E-commerce businesses can use online marketing tools, including social media, email, and search engine optimization (SEO), to reach their target audience, which can be more cost-effective than traditional marketing methods.
- Personalized Shopping Experience: E-commerce websites can use customer data to provide a customized shopping experience, such as recommending products based on a customer’s purchase history or browsing behavior.
Challenges of an E-commerce website:
- Security Risks: E-commerce websites are vulnerable to security risks, such as data breaches and credit card fraud, which can damage a company’s reputation and result in financial losses.
- Technical Issues: E-commerce websites can experience technical issues such as server downtime, slow page loading times, and website crashes, which can result in lost sales and frustrated customers. E-commerce websites also face the need for ongoing maintenance and updates. As technology evolves, websites must keep up with the latest trends and features to remain competitive.
- Lack of Personal Interaction: E-commerce websites need more personal interaction than customers may get when shopping in a physical store, making it difficult for businesses to build relationships with their customers.
- Shipping Costs and Return Process. E-commerce businesses may incur higher shipping costs than traditional ones, particularly for international orders or large, bulky items. Also, managing product returns can be costly and time-consuming..
- Need for Systems Integration: E-commerce websites must integrate with other systems such as payment gateways, inventory management software, and accounting software. This further increases the costs of maintaining a website.
The decision to build an e-commerce website should be made after carefully considering the costs, benefits, and challenges involved. Still, while there are challenges, an e-commerce website can be a game-changer for businesses, it has become a major component of modern business providing access to a global customer base and generating significant revenue.
(Note: This article is for general information purposes only. The specific accounting treatment of web design and development cost may vary based on the accounting standards where the business operates. It is recommended to consult a licensed Accountant for guidance on the appropriate accounting treatment)