In today’s business environment, cloud computing arrangements play a key role in the day-to-day operations of companies large and small. The Financial Accounting Standards Board’s (FASB) Accounting Standards Update (ASU) 2015-05 helps fill some of the gaps, though not all, regarding the proper accounting for such arrangements. Following a recent Emerging Issues Task Force (EITF) meeting, the FASB is further considering aligning the accounting for cloud computing arrangements with the accounting for software licenses, so there is more to come in that regard. However, this article provides an overview of cloud computing arrangements, clarification on which types of hosting arrangements are considered under the current accounting principles, and further guidance on which costs to expense or capitalize in hosting arrangements that include a software license.
Cloud computing arrangements include “software as a service” (SaaS), “infrastructure as a service” (IaaS), “platform as a service” (PaaS), and a variety of other hosting arrangements, such as storage, database, application, security, and management. A “hosting arrangement” is defined as an arrangement in which the end user does not take possession of the software. Instead, the software remains on the vendor or third party’s server, allowing the user access to the software over the Internet on an as-needed basis.
Customers of cloud computing arrangements should first evaluate the type of hosting arrangement they have in order to apply proper accounting. If the cloud computing arrangement includes a software license, the customer should account for it as an acquisition of an intangible asset. If the arrangement does not include a software license, and the customer is simply obtaining the right to receive hosting services for a fee, the customer should account for the arrangement as a service contract.
It is important to note that, in order for a hosting arrangement to be accounted for as a purchased intangible asset, the hosting arrangement must be for internal use and meet both of the following criteria:
If these requirements are not met, the cloud computing arrangement does not include a software license, and must be accounted for as a service contract. However, if the requirements are met, customers account for the software license purchase at cost, which is the present value of the license obligation, amortized over its useful life.
ASC 350-40: Accounting for Business Combinations, Goodwill, and Other Intangible Assets provides further guidance on which costs can be expensed as incurred and which costs must be capitalized in the acquisition of a software license. Those that may be expensed include the following:
Internal and external costs incurred during the application development stage are capitalized as part of the cost of the software license. Capitalization of costs ceases when the software project is ready for its intended use after all testing is completed. In other words, when the software is placed in service, no further costs can be capitalized, and the software is then amortized over its intended useful life.
ASU 2015-05 does not contain explicit guidance regarding implementation costs of cloud computing arrangements that are service contracts. While the FASB’s recent task force meeting addressed concerns regarding the absence of guidance regarding this topic, a final decision has not yet been made. Until that such time, customers are expected to refer to existing Generally Accepted Accounting Principles to develop a reasonable accounting method for cloud computing arrangements that do not include a software license.
If you would like more information about accounting for cloud computing arrangements, or would like to request a speaker on this topic for your organization or event, contact one of our PYA executives below at (800) 270-9629.