It may seem like FASB has been cranking out changes to accounting standards at an accelerated pace, but even so, the Board has had a tough time making sure that the standards keep up with the ways technology is changing how we run our businesses. Cloud computing is an example of that, so FASB recently updated its guidance for cloud computing arrangements in Accounting Standards Update (ASU) 2018-15, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Service Arrangement That Is a Service Contract.
Under the previous guidance from 2015, Accounting Standards Update (ASU) 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, implementation costs received inconsistent treatment, depending on the details of the contract. For licensed software, the guidance for internal use software applied, so certain implementation costs were to be capitalized.
However, for software obtained through a service contract, such as a SaaS arrangement, all fees were to be expensed as incurred. The 2015 update had no guidance for implementation costs, which can be just as substantial for a SaaS arrangement as for a software licensing arrangement.
Consistent treatment for implementation costs
With the new update, the guidance for internal-use software is to be applied to all cloud computing arrangements, including SaaS arrangements. In brief, implementation costs are to be capitalized, while all other costs can be expensed.
Costs to be capitalized
Whether a cost should be capitalized or expensed depends on the phase of the implementation process and the nature of the costs. Implementation costs to be capitalized include the following:
- Costs during the application development phase of implementation, which can include coding and testing.
- Costs to develop or purchase software to convert or access data from the old system by the new system.
- Costs for configuring or customizing the service, whether by third party or internal.
- Travel for service providers who are assisting with the implementation process on-site.
- Payroll for employees while they are involved in implementation phase.
Costs that can be expensed include these types of expenses:
- Training, even if this training occurs during the development or implementation stages.
- Costs incurred during the preliminary project and post-implementation phase.
- Costs for data conversion, which include purging or cleansing old data, reconciling between systems, creating new or additional data, and conversion to the new format.
If the vendor does not provide an itemized detail of the fees, the breakdown between types of costs and the phase of the project may need to be estimated. When implementing software across separate locations or business units, each location or instance must be treated as a separate instance of the software. Likewise, costs and fees for separate modules of the software should also be allocated to each module.
Amortize over term of service
Capitalized costs are to be amortized straight line over the term of service unless there is another method that better reflects how the organization will benefit from the software. The term of service may include periods to extend the original contract if the organization is reasonably certain that the contract will be extended. The amortization period may also be impacted by other circumstances, such as options that are under the control of the vendor. Amortization begins when a module is ready to be used.
Obsolescence, changes in technology, competition from others and general economic factors may all impact useful life of the software, so the amortization period should be periodically reassessed. If conditions indicate that the amortization period should be changed, this will be treated prospectively as a change in estimate.
Likewise, periodic assessments for impairment may be needed if there are changes to the usefulness of the software or changes in the hosting arrangement. This may need to be done by module or location.
Public entities need to implement this for fiscal years beginning after Dec. 15, 2019. All other entities have an extra year. Implementation may be performed either prospectively or retrospectively.
While this update now requires capitalization of costs that were previously expensed as incurred, it does make the treatment of implementation costs consistent across all types of cloud computing arrangements. Because some cloud computing arrangements may contain elements that are licenses and elements that are services, this should ultimately simplify the accounting for your clients, and more accurately reflect the nature of the arrangement.