For generally accepted accounting principles (GAAP) to remain relevant in today’s business environment, the FASB must increasingly address new topics. Whether it’s new financing instruments, investments, or technological advancements, if it affects inflows or outflows of funds or financial reporting, the FASB needs to consider the impact on entities and the corresponding accounting treatment.
Cloud computing is one such topic. Examples of cloud computing arrangements include software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements. A new accounting standard, effective for years beginning after December 15, 2015 (calendar year 2016), addressed accounting for cloud computing costs:
- Accounting Standards Update (ASU) 2015-05, Intangibles – Goodwill and Other – Internal-Use Software – Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement
The ASU provides guidance to customers in accounting for costs paid for cloud computing. The accounting treatment depends on whether a cloud computing arrangement (CCA) includes a software license. If a CCA includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a CCA does not include a software license, the customer should account for the arrangement as a service contract.
The ASU provides guidance on determining whether a software license exists. Both of the following criteria must be met:
- The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
- It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.
The guidance affected the accounting for all software licenses by requiring them to be accounted for in the same manner, consistent with accounting for other licenses of intangible assets.
Aspects of the ASU met with strong opposition as noted in comment letters the FASB received when it proposed the standard update. To many, the determination of whether or not a software license is included in the arrangement was not seen as a defining element. Another common theme was a request for the FASB to address the accounting for implementation, setup, and other upfront costs that are often incurred by customers entering into CCAs. Ultimately, the FASB did not address the accounting for these costs in ASU 2015-05 on the basis that for arrangements which transfer a software license, existing guidance instructs how to account for such costs, and for arrangements which do not transfer a software license, a CCA is not unique in having upfront costs. This conclusion by the FASB has caused many to infer that the FASB’s intent was for entities to expense these costs in CCAs without a software license.
But a definitive answer the issue of implementation costs remains. The FASB continues to receive pressure from practitioners and entities to issue additional guidance. These costs can be significant, and respondents want clarification from the FASB. The FASB has addressed this concern by adding the issue of accounting for upfront CCA costs to the agenda of the Emerging Issues Task Force (EITF), an organization formed by the FASB to assist with addressing financial reporting issues on a timely basis.
At the October 12, 2017, EITF meeting, discussions were leaning toward amending GAAP to allow businesses to capitalize more costs associated with implementing cloud systems. By capitalizing the costs, businesses will be able to recognize them as a long-term asset and amortize them over the life of the software contract instead of recognizing a large expense at the contract's outset. The EITF concluded its meeting by requesting staff to provide more research on the need for guidance on capitalizing software setup costs before the Task Force will make a recommendation to the FASB.
It’s definitely a “stay tuned” topic that we will continue to monitor and provide updates on to keep you informed.