New Accounting Guidance Regarding Cloud Computing Arrangements
Implementation Costs Incurred in a Cloud Computing Arrangement (ASU 2018-15)
The Financial Accounting Standards Board (FASB) recently issued 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 Arrangement That Is a Service Contract. The purpose of this ASU is to provide additional guidance on how to properly account for the costs incurred when implementing or taking part in a cloud computing arrangement. Specifically, ASU 2018-15 gives practitioners insight when accounting for cloud computing arrangements that are also service contracts – that is to say, a contract where the purchased software continues to be hosted by the vendor. The new guidance also prescribes the balance sheet, income statement, and cash flow classifications for any capitalized implementation costs and the related amortization expense.
Current Generally Accepted Accounting Principles (GAAP) in the United States regarding the accounting for cloud computing arrangements are derived from ASU 2015-05, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40); Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, issued by the FASB in April of 2015. ASU 2015-05 helps entities evaluate the accounting for fees related to a cloud computing arrangement (otherwise known as a hosting arrangement). In particular, ASU 2015-05 provides guidance on how to distinguish between an arrangement that includes a software license and one that does not.
If the arrangement does include a license to internal-use software, this generally means that an intangible asset should be recognized for the software license, and, to the extent that the payments attributable to the software license are made over time, a corresponding liability should also be recognized. When the arrangement does not include a licensing component – rather, it is hosted by the vendor – then the arrangement is classified as a service contract, and fees that are generally associated with the service contract are expensed as incurred.
Although ASU 2015-05 addressed the accounting for fees paid during the term of a hosting arrangement, it did not explicitly address how to account for implementation expenses related to a cloud computing arrangement classified as a service contract, or whether any of the costs incurred under a cloud computing arrangement could (or should) be capitalized. Several stakeholders requested additional guidance, and ASU 2018-15 aims to address the resulting diversity in how various entities are accounting for these arrangements.
Entities that enter into hosted service arrangements will now apply the existing internal-use software guidance to determine which implementation costs are eligible for capitalization. Costs are capitalized or expensed based on the nature of the underlying expense, as well as the project stage in which the costs are incurred. It is important to note that certain costs can never be capitalized for hosted service arrangements under this model, regardless of the stage they are incurred in. Examples of such ineligible costs are training costs and certain data conversion costs.
Besides determining the nature of the cost, entities must also determine which project stage an implementation activity relates to (preliminary project stage, application development stage, or post-implementation stage). Costs incurred during the application development stage are generally capitalized, whereas preliminary and post-implementation costs are generally expensed as they are incurred. Both internal and external costs in the development stage are eligible for capitalization. For example, fees paid to the vendor to customize the service could be capitalized, as could the cost of employees’ time dedicated to the implementation of the software during the development phase.
Any costs capitalized during the implementation of the hosted service arrangement under ASU 2018-15 should be expensed over the term of that arrangement. The term of the arrangement is calculated as follows: the noncancellable period of the arrangement, plus any options to extend the arrangement if the entity is reasonably expected to exercise that option, or any options to extend the arrangement at the option of the vendor. Entities will also need to apply existing guidance on evaluating capitalized costs for impairment as if the costs were long-lived assets.
The amendments in ASU 2018-15 also provide guidance for how to classify implementation costs on the financial statements. The ASU requires that capitalized implementation costs for hosting arrangements be included in the same balance sheet line item as prepaid hosting arrangement fees. Likewise, amortization for these capitalized costs should be expensed on the income statement within the same line item as fees associated with the ongoing hosting element of the arrangement. Lastly, actual payments made for such capitalized implementation costs need to be presented on the statement of cash flows in the same manner as payments made for the fees in the ongoing hosting element.
In summary, the ASU 2018-15 provides additional guidance for which implementation costs associated with a hosted service arrangement can be capitalized, and which costs should be expensed as incurred. This guidance is timely, as cloud computing arrangements are consistently becoming more commonplace. The amendments in this update clarify that, while the fees associated with the hosting element of the arrangement are expensed as incurred, there are in fact implementation costs associated with these arrangements that can be capitalized and expensed over the term of the arrangement.
For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. All other entities should apply the amendments for annual reporting periods beginning after December 15, 2020 and interim periods within annual periods beginning after December 15, 2021. Entities may choose between either a prospective or retrospective transition. Early adoption of the amendments is permitted.
If you have any questions regarding ASU 2018-15, please contact Spencer Hathaway or your BNN advisor at 800.244.7444.
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