Capitalization of Cloud Computing Costs
Moving data, applications and platforms to the cloud creates substantial business benefits as companies reduce capital expense outlays while maintaining a more flexible IT environment. Though the advantages are numerous, companies pursuing cloud computing solutions need to consider the financial reporting implications as well as broader tax and IT considerations that result from existing guidance on accounting standards effective in 2020 for public business entities.
Background: ASC Subtopic 350-40 and ASU 2015-05
The Financial Accounting Standards Board (FASB) originally provided guidance on how to account for software that is developed or obtained for internal use in ASC Subtopic 350-40. Further amendments to the Subtopic were later provided in ASU 2015-05, designed to help entities evaluate whether a hosting arrangement included an internal-use software license for accounting purposes. Examples of hosting arrangements include software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements.
ASU 2015-05 stated that if an arrangement contains a software license, the customer should generally capitalize and subsequently amortize the cost of the license, as well as recognize a liability for future payments associated with the software element. When a hosting arrangement is deemed not to include a software license for accounting purposes, the arrangement is accounted for as a service contract and fees are expensed as incurred.
The amendments in ASU 2015-05 did not address the accounting for costs incurred to implement a hosting arrangement that is a service contract, and stakeholders requested that the FASB provide additional guidance for those implementation costs. The FASB acknowledged that codified guidance was not explicit in that area, and therefore decided to issue a new ASU to address the existing diversity in practice.
Later Guidance: ASU 2018-15
In August 2018, the FASB issued ASU 2018-15 to address requests for additional guidance on accounting for implementation and other upfront costs associated with hosting arrangements that do not contain a software license and are therefore considered service contracts.
The FASB Emerging Issues Task Force concluded that implementation costs of a hosting arrangement that is a service contract are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred, consistent with costs for internal-use software. Costs incurred during the application development stage of implementation are capitalized depending on the nature of the costs, whereas costs incurred during the preliminary project and post-implementation stages are expensed as the implementation or other activities relevant to that stage are performed. It was decided that the implementation costs of a hosting arrangement that is a service contract provide a future benefit to the entity beyond the period over which the implementation services are performed, and therefore could be attached to the service contract and be capitalized as an asset recognized over a period longer than the period over which the implementation services are provided.
The Task Force decided that there was no need to provide a definition of the term implementation costs beyond what is already provided in Subtopic 350-40. Costs to develop or obtain internal-use software that cannot be capitalized under Subtopic 350-40, such as training costs and certain data conversion costs, also cannot be capitalized for a hosting arrangement that is a service contract. The amendments require a customer in a hosting arrangement that is a service contract to determine whether an implementation activity relates to the preliminary project stage, the application development stage, or the post-implementation stage. Costs for implementation activities in the application development stage will be capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post-implementation stages will be expensed immediately.
A consensus was reached to require entities to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement, which includes customer renewal options that are reasonably certain to be exercised and all contractual renewal options controlled by the vendor.
Accounting Presentation
ASC 2018-15 guidance clarifies that the capitalized implementation costs are not long-lived assets, which is reflected in the presentation guidance summarized in the following table:
Financial Statement |
Presentation |
|---|---|
Balance Sheet |
Present capitalized implementation costs in the same line item that a prepayment for the fees of the associated hosting arrangement would be presented. |
| Income Statement |
Reflect expense related to the capitalized implementation costs in the same line item as the fees associated with the hosting element (service) of the arrangement. Accordingly, amortization expense related to those implementation costs cannot be presented along with depreciation or amortization expense for PP&E and intangible assets if such depreciation or amortization is presented separately in the income statement. |
Statement of Cash Flows |
Classify payments for capitalized implementation costs consistent with payments made for fees associated with the hosting element. |
Note that the asset recognized for the implementation costs is recognized only as a result of enhancing the value of the hosting service, which itself is not recognized as an asset. Thus, although the implementation costs are recognized as a standalone asset, the future benefit derived from that asset is linked to the benefit derived from the hosting service, which is expensed as incurred.
Effective Dates and Transition
The Task Force decided that the amendments in ASU 2018-15 should be effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For all other entities, the amendments are effective for all fiscal years beginning after December 15, 2020, and all interim periods beginning after December 15, 2021. Early adoption is permitted, including adoption in an interim period.
Amendments should be applied prospectively to all implementation costs incurred after the date of adoption or retrospectively. Transition disclosures depend on the transition method selected.
How Lucasys Can Help
Lucasys provides in-depth expertise in financial reporting revisions, analysis of the tax impacts of recent accounting changes, and adopting cloud computing solutions. To learn more about how Lucasys can assist, please visit https://www.lucasys.com/solutions.