For generally accepted accounting principles (GAAP) to remain relevant in today’s business environment, the Financial Accounting Standards Board (FASB) must increasingly address new topics. Whether it’s new financing instruments, investments or technological advances, if it affects inflows or outflows of funds or financial reporting, FASB needs to consider the impact and the corresponding accounting treatment.
Cloud computing is one such topic. Examples of cloud computing arrangements (CCAs) include software as a service (SaaS), platform as a service (PaaS) and infrastructure as a service (IaaS).
ASU 2018-15 clarifies the accounting for the implementation costs of a hosting arrangement that is specifically a service contract, as well as predominantly aligns the accounting for the implementation costs for hosting arrangements regardless of whether they convey a license to the hosted software.
The treatment of implementation costs for all CCAs now follows a similar path. Costs should be evaluated following the rules for internal-use software (ASC Subtopic 350-40), which is a good answer for those looking to spread a portion of the costs over time.
The accounting for the service element of a hosting arrangement that is considered a service contract is not affected by the amendments in the update. Additionally, costs to develop or obtain internal-use software that can’t be capitalized under Subtopic 350-40, such as training costs and certain data-conversion costs, also can’t be capitalized for a hosting arrangement that’s a service contract.
This means that a customer in a hosting arrangement that’s a service contract can determine which project stage (e.g., preliminary project stage, application development stage or post-implementation stage) an implementation activity relates to. The costs for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post-implementation stages are expensed as the activities are performed.
ASU 2018-15 does establish a subsection of ASC 350-40 specifically for implementation costs of a hosting arrangement that is a service contract. The subsection of ASC 350-40 includes certain requirements specific to hosting arrangements that are service contracts, such as requirements for determining the term of the contract as well as presentation requirements.
Term: The term of the contract, over which the capitalized costs will be amortized, is the fixed noncancelable term plus the periods covered by the following options: (a) options to extend the arrangement if the entity is reasonably certain to exercise that option, (b) options to terminate the arrangement if the entity is reasonably certain not to exercise that option and (c) options to extend or not terminate the arrangement that are controlled by the vendor. Entities should periodically assess the estimated term.
Presentation: ASU 2018-15 also includes requirements on how the components of CCA that is a service contract are presented in the financial statements:
- Amortization of capitalized implementation costs should be reported in the statement of income in the same line item as the expense for fees for the hosting arrangement.
- Capitalized implementation costs should be presented in the balance sheet in the same line item that a prepayment of the fees for the hosting arrangement would be presented.
- Cash flows from capitalized implementation costs should be reported in the same manner as cash flows for the fees for the hosting arrangement.
Effective Dates and Transition
The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019. For all other entities, the amendments are effective for annual reporting periods beginning after December 15, 2020.
Early adoption of the amendments in this update is permitted, including adoption in any interim period, for all entities. The amendments should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption.
If you have any questions about ASU 2018-15 and what your options are, contact Wipfli.