FASB proposes updated standard for cloud computing
Published April 5, 2018
The Financial Accounting Standards Board (FASB) recently issued a proposal to clarify how to account for the costs of setting up business software packages that are managed in the cloud. If finalized, the proposal would let more of the costs of implementing a cloud computing contract be spread over the contract’s life.
Reporting hosting arrangements
In April 2015, the FASB published Accounting Standards Update (ASU) No. 2015-05, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. The updated guidance helps businesses evaluate whether a cloud computing (or hosting) arrangement includes an internal-use software license.
When a hosting arrangement doesn’t include such a license, the arrangement must be accounted for as a service contract. This means businesses must expense the costs as incurred.
On the other hand, when the arrangement does include such a license, the customer must account for the software license by recognizing an intangible asset. To the extent that the payments attributable to the software license are made over time, a liability is also recognized.
The amendments in ASU No. 2015-05 didn’t address the accounting for the costs incurred to implement a service contract for a hosting arrangement, however.
Focusing on implementation costs
Over the last three years, companies have increasingly rejected servers installed at their premises in favor of cloud-based solutions. But the costs to set up the cloud services can be significant, and many companies would prefer not to immediately expense these setup costs.
In March 2018, the FASB issued Proposed ASU No. 2018-230, 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; Disclosures for Implementation Costs Incurred for Internal-Use Software and Cloud Computing Arrangements.
Businesses told the FASB that they see no economic difference between a contract that includes a license to run the software locally and a contract to have the application run on the cloud. So, they wanted to use similar accounting treatment for both types of contracts. As a result, the proposal would require consistent reporting for implementation costs for 1) a hosting arrangement that’s a service contract, and 2) developing or obtaining internal-use software (that a company runs on its servers or servers operated by a third party).
If the proposed changes are finalized, a customer in a cloud computing contract would have to include in the footnotes to its financial statements information about the software it purchases. The accounting for the service element of the hosting arrangement wouldn’t be affected by the proposed amendments.
Under the proposal, companies should refer to Accounting Standards Codification (ASC) Subtopic 350-40 on internal-use software to determine which implementation costs associated with a service contract for a cloud computing arrangement can be capitalized as an asset. The costs that can be capitalized will be treated as long-term assets and amortized over the life of the arrangement — not booked as an expense at the contract’s outset.
Expenses for developing or obtaining internal-use software that can’t be capitalized under the rules for intangibles — such as the costs for training and data conversion — wouldn’t be capitalized for a hosting arrangement that’s a service contract. The customer in the hosting arrangement would determine which of the three stages an implementation activity relates to:
- The preliminary project stage,
- The application development stage, or
- The postimplementation stage.
Implementation costs at the application development stage would be capitalized depending on their nature. But costs that are incurred during the preliminary project and postimplementation stages would be expensed as the activities are performed.
The amortization period would generally be the term of the hosting arrangement. This would include the noncancelable period of the arrangement, plus periods covered by any options to:
- Extend the arrangement if the customer is reasonably certain to exercise that option,
- Terminate the arrangement if the customer is reasonably certain not to exercise the termination option, and
- Extend (or not to terminate) the arrangement in which exercise of the option is in the control of the vendor.
Customers would need to reassess the estimated term of the arrangement periodically and account for any change in the estimated term as a change in accounting estimate.
The FASB is asking for public comments by April 30. Right now, no effective date has been set. Once its Emerging Issues Task Force (EITF) has an opportunity to review the feedback, the FASB will announce the next steps for this project and, if finalized, when the changes will go into effect.