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Project Partners Blog Author: Donna Dignam | Principal Functional Consultant
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In April 2015, FASB (Financial Accounting Standards Board) issued ASU (Accounting Standards Update) 2015-05 to assist entities in determining when a customer in a cloud computing arrangement “CCA” (i.e., hosting arrangement) included a software license.
If a CCA includes a license to internal use software, the software license is accounted for by the customer as an intangible asset. The intangible asset is recognized for the software license, and the payments or said license made over time are recognized as a liability. If no software license is included in the contract, the company should account for the arrangement as a service contract, and the fees associated with the hosting service of the arrangement are expensed as incurred.
The update did not give guidance regarding the implementation costs for activities performed in a cloud computing arrangement as a service contract. Since the FASB guidance in this area was not explicit, the Board decided to issue an Update to address the resulting diversity in practice.
Who Is Affected by ASU 2018-154?
These Amendments on the accounting for implementation, setup, and other upfront costs (commonly referred to as implementation costs) apply to entities that are a customer in a hosting arrangement that is a service contract. Oracle Cloud computing arrangements, where a license is sold to the customer and a hosting arrangement with Oracle Cloud, would be one such customer.
Main Provisions of ASU 20184
The Update intends to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. The current accounting for the service element of a hosting arrangement is not affected.
It is up to the company to determine which implementation costs to capitalize as an asset related to the service contract and which to expense. Costs to develop or obtain internal-use software that could not be capitalized under Subtopic 350-40, such as training costs and specific data conversion costs, also cannot be capitalized for a hosting arrangement that is a service contract. The company in a hosting arrangement that is a service contract determines which project stage an implementation activity relates to. Project stages include the preliminary project stage, application development stage or post-implementation stage. Costs incurred for the application development stage are capitalized, while those costs related to the preliminary project stage or the post-implementation stage are expensed as the activities are performed.
In addition, the company must amortize the capitalized implementation costs over the terms of the hosting arrangement. The term of the hosting arrangement includes the noncancellable period of the arrangement plus periods covered by:
- Option to Extend – customer must be reasonably expected to exercise this option
- Option to Terminate the Arrangement – where the customer is reasonably expected NOT to exercise this option
- Option to Extend or Not to Terminate – where the vendor can exercise the option.
Impairment guidance, as if the costs were long-lived assets, and abandonment are to be applied based upon the existing guidance in SubTopics 350-40 and 360-10, respectively.
The income statement presentation by the entity should be the same line item as the fees associated with the hosting service of the arrangement. Similarly, the classification of payments for capitalized implementation costs in the Statement of Cash Flows is done similarly to payments made for fees associated with the hosting arrangement. In the Statement of Financial Position, capitalized implementation costs are presented in the same line item that a prepayment for fees associated with the hosting arrangement would be presented.
How is This Different, and Why is it an Improvement?
GAAP does not explicitly address accounting for implementation costs associated with a HASC. Therefore, the Update improves current GAAP as it clarifies accounting and aligns the accounting for implementation costs for hosting arrangements, regardless of whether a license is conveyed.
For consulting firms, the new standards present an improved selling point as costs previously required to be expensed can now be capitalized. For capital-intensive industries, where cloud applications are being considered and dismissed due to financial considerations around increased expenses (and resulting decreased profitability metrics) due to cloud implementation, the new standard allows a way to capitalize the costs associated with both the license and the implementation and development costs around getting that application stood up.
When Does This New Update Take Affect?
For public entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, annual reporting periods beginning after December 15, 2020, and interim periods within annual periods beginning after December 15, 2021, are required. Early adoption is permitted at any time.
The amendments in this Update should be applied retrospectively or prospectively to all implementation costs incurred after the date of adoption.
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