Cloud-based software has grown in prevalence, and many companies find it an effective way to reduce upfront capital investment in software and outsource the upkeep of those systems. As technology has advanced, systems available on the cloud have increased in their size and complexity. These more complex systems have begun to require significant implementation costs in their own right to configure and integrate.
The Financial Accounting Standards Board (FASB) recently released an accounting standards update that explains how to account for those implementation costs that may result in companies needing to track, capitalize, and compute amortization for costs in new ways.
Previous Cloud Computing ASU Creates Questions
FASB accounting standards update 2015-05, Intangibles—Goodwill and Other Internal Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement (ASU 2015-05) provided guidance to help distinguish when a cloud computing arrangement (or hosting arrangement) would be treated as the purchase of a license to internal-use software (that is an asset) and when it would be treated as a service contract. Under that guidance, the most common forms of cloud-based software arrangements are accounted for as a service. As a service, fees associated with the arrangement are expensed as incurred.
The accounting guidance did not address how to account for costs associated with implementing the hosting arrangement. The lack of clear guidance resulted in some diversity in practice, with many companies concluding that the implementation costs of cloud-based services should be expensed as incurred, resulting in higher expenses when implementing a cloud based system then if the same company acquired a license to internal-use software and capitalized implementation costs. Stakeholders asked for additional guidance on how to account for implementation activities for cloud computing service contracts, which is addressed by ASU 2018-15, Intangibles—Goodwill and Other Internal Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (ASU 2018-15).
Cloud Computing Questions Answered
In ASU 2018-15, the FASB clarifies that customers in a cloud computing service contract should follow the same implementation cost guidance as followed when purchasing a license to internal-use software. This is expected to result in smoother expenses related to cloud computing service arrangements that is similar to the expense pattern for when a company purchases a software license.
Under the guidance for implementation costs, a customer that first implements a cloud-based software that is a service would capitalize cost or expense costs by analyzing what stage of the project the costs were incurred during and the nature of the costs. There are three phases to a project:
- Preliminary project stage
- Application development stage
- Post implementation/operation stage
Only costs incurred during the application development stage, which is analogous to the construction of an asset, are able to be capitalized Typical costs eligible for capitalization are direct external costs, payroll costs, and interest (under ASC Topic 835, Interest) related to the configuration of the software, writing software code to integrate systems or software used to convert data, and testing activities. Costs that will continue to be expensed when incurred are indirect costs (general and administrative costs), training costs, and data conversion costs (such as payroll costs related to the input of data). Once the software is made available for use (i.e. testing is substantially complete), implementation costs would be expensed.
An added complexity will be the need to track costs by software by module or component. The capitalized costs are written off when each module or component of the software is abandoned (ceases to be used). The costs will be subject to amortization on a straight line method unless there is a more representative systematic and rational model that reflects the benefits of being able to access the software. The amortization period for the costs is the term of the cloud computing service arrangement, which includes the noncancellable period of the arrangement, plus any period covered by an option to renew that the customer is reasonably certain to exercise. The term of the arrangement also includes periods covered by an option to terminate the arrangement if the customer is reasonably expected not to exercise the termination option, and the option to extend the arrangement in which exercise of the option is in control of the vendor. Considerations to include when evaluating which optional periods to include:
- Technological obsolescence and the pace of development,
- Competition, and
- The economic value of significant implementation costs.
Amortization of implementation costs begins when each module or component of the cloud software becomes available for use. If a module is functionally dependent on another module that is not available for use, amortization would begin when the latter module is available for use.
Customers in service contract arrangements will apply the impairment and abandonment guidance under ASC Topic 360, Property, Plant, and Equipment.
Presentation and Disclosures of Cloud-Computing Implementation Costs
Customers in service contract arrangements must present the expense related to the capitalized implementation cost in the same line item as fees associated with the service of the arrangement in their statement of income. Payments for classified implementation costs must be classified in the statement of cash flows in the same manner as payments made for fees associated with the hosting element, generally as an operating activity instead of an investing activity. Customers will be required to present the capitalized implementation costs in the same line item as prepayments for fees associated with hosting arrangements in the statement of financial position.
In a change from the original proposal, the only disclosures that will be required related to the cloud computing arrangements is a description of the nature of the arrangement and the disclosures required under ASC Topic 360, which include the amortization expense in the period, balance of the capitalized costs, accumulated amortization, and the method of amortization.
ASU 2018-15 takes effect for public businesses for fiscal years and interim periods beginning after Dec. 15, 2019 (generally the 2020 calendar year). All other entities will adopt for annual periods beginning after Dec. 15, 2020 (2021 calendar year) and interim periods beginning after Dec. 15, 2021 (2022 calendar year). Early adoption is permitted.
The adoption method could be applied either retrospectively or prospectively to all implementation costs incurred after the adoption date.
For More Information
If you have specific comments, questions, or concerns, please contact Mark Winiarski of MHM's Professional Standards Group. Mark can be reached at firstname.lastname@example.org.
Published on September 12, 2018