Many companies and accounting firms have been focusing on new standards on revenue recognition and accounting for leases, hedging, and credit losses. But another new FASB standard — on cloud computing costs associated with a service arrangement — became effective for public business entities in fiscal years beginning on or after Dec. 15, 2019, and will take effect for all other entities for reporting periods beginning after Dec. 15, 2020.
Accounting Standards Update No. 2018-15, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Service Arrangement That Is a Service Contract, issued in August 2018, is designed to reduce complexity in accounting for costs of implementing a cloud computing service arrangement. The standard now aligns 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 amendments do not affect the accounting for the service element of a hosting arrangement that is a service contract.
"There had been two different capitalization models, depending on whether or not you're buying a service contract or you're buying an asset," said Chris Chiriatti, CPA, an audit and assurance managing director at Deloitte & Touche LLP. "So, in 2015 the FASB issued guidance that clarified what really was the purchase of an asset and what was buying a service. However, guidance on how to account for implementing a cloud computing service contract was not covered."
As time progressed, Chiriatti said, many companies were moving their activities to the cloud.
"That resulted in accounting outcomes for buying a service contract versus buying an asset looking very different from a balance sheet and income statement presentation standpoint, even though the way the technology was being used was substantially the same," he said.
ISSUES TO CONSIDER
Companies should be prepared to implement the standard by considering some issues it presents.
"I think the biggest challenge is that there is an element of fatigue in the marketplace because of the substantial accounting changes that have occurred," said Sean Torr, CPA, a risk and financial advisory managing director at Deloitte & Touche LLP. "While this standard is not as pervasive as some of the others, it does introduce some complexity around management judgment. Some of these costs will be subject to the deferral aspect, where others may not be, and so companies will have to exercise judgment on which costs would qualify for deferral and which would not, for example."
Another challenge surrounds completeness, Torr said. "Companies are moving quickly to the cloud. In a lot of situations, that's occurring in a decentralized manner. There is an element of making sure that they track and capture all these contracts and are fully assessing the implications for the company. They need some solution to capture the costs that should be deferred and then allocated to P&L over the term of the contract. I think many companies have similar processes in place for internal-use software, so they could piggyback off that, but there are some additional nuances that need to be considered in relation to cloud computing arrangements."
Chiriatti added that hybrid arrangements require companies' close attention as well. He said it's important for companies to understand the differences in which costs would be characterized as internal-use and which would be considered part of the service arrangement, especially as companies are developing and deploying hybrid arrangements.
"Because the standard does require a new lens to look at costs associated with a service arrangement, existing policies might need to be adapted or new processes put in place to make sure the costs are getting properly identified and captured," he said.
"There is a potential advantage for the standard because of the deferral aspect of the costs that qualify," Torr said. "There will be impacts on some of the company's key performance indicators. It may not be substantial for many companies, but it's something to be considered. EBITDA and certain balance sheet metrics, just to name a couple, would be impacted by this deferral."
Another advantage: "It does improve financial reporting," Chiriatti said. "The standard eliminates some diversity in practice and aligns the balance sheet and income statement in the aggregate for both internal-use software or service contracts for cloud computing arrangements when it's really the same underlying functionality."
Consistency and comparability are important in this area, according to Brenda Morris, CPA, CGMA. "I've seen the accounting done five or six different ways among companies I've worked with," said Morris, a partner with CSuite Financial Partners, which provides financial consulting services to organizations in all industries. "So having this new guidance is very positive, and now it's just a matter of getting to the right answer."
Getting to the right answer is a challenge, though, and one that requires management to be deeply involved in the decision-making around IT projects, she said. "The past few years have been confusing for most management teams, and definitely for most financial planning and analysis teams. A common concern has been how we budget for cloud-based accounting implementations and the ongoing service provider costs versus in-house development or on-premise development," Morris said. "I can tell you there's been fairly healthy debates in companies around what is the right accounting and trying to decide whether to go with a cloud-based solution or an on-premise solution because of the impact it will have on the financial statements and reported performance."
SKILLS NEEDED AND THE FUTURE
According to Torr, many of the project management activities done to implement the other new standards could be employed here. Stakeholder communications is one example. As with implementation of the revenue recognition and lease accounting standards, it's important to put together a multifunctional project management team, map the project's progress with goals and accountabilities, and train personnel to handle the transition. Controls also need to be appropriately designed and operate effectively.
"I think having a road map around the company's future plans for cloud computing would be important," Torr said. "Understanding the impact on the key performance metrics or any impact on the company's financial covenants is critical, as is change management of the solutions to capture the costs. There's obviously a fair amount of technical nuances involved here, in addition to management judgment. So have a clearly defined policy around this, and make sure it is appropriately vetted with the stakeholders and particularly the auditors."
Complying with the standard takes strong project management or a steering committee, according to Morris, because there are subtle distinctions in how cloud computing systems are being implemented. She said questions to ask include: What part of the project is hardware? What part of it is software? What part of it is software as a service? Which parts do you own?
"The finance team needs to see how an IT project comes together, what the factors are and what the accounting treatment is according to the standard, so that you don't end up at audit time realizing you should have accounted for certain aspects differently or accounted for similar aspects inconsistently," she said. "You can partner with and help your IT team by educating them on the accounting rules and how parts of projects are characterized, to understand the financial impacts."
Those involved in implementing the standard need to understand what data and information they're going to need to appropriately apply the standard, Chiriatti said.
"Some of that might not be coming from internal sources," he added. "There might need to be dialogues with vendors, cloud vendors, or service providers to get greater insight into the type of activities they're doing because certain costs still have to be expensed as incurred; examples are costs for training or those associated with migrating data to the new platform. But the application development type costs would be deferred."
ACHIEVING BETTER OUTCOMES
Morris suggests companies keep their eyes on the financial accounting and metrics for already completed cloud computing projects or those in the pipeline. "You don't want to trip a bank covenant or something similar just because of a change in accounting treatment," she said. "You should discuss adjustments with your board of directors, lenders, and other financial statement users to explain the reasons behind the changes due to implementation of the new standard."
Another insight for companies from Morris: "Implementing any standard and figuring out what the impact is going to be, though challenging, gives companies an opportunity to gain helpful analysis and a path to better, more cohesive, and consistent outcomes."
"I think this is another good example of accounting needing to get closer to the business," said Torr. "There's a lot going on in the changing of the IT landscape that has implications for the controllership," he said. "Close collaboration and teaming between the CFO, controller, and IT would yield more strategic outcomes. There is a need to be providing at least some forward-looking advice and counsel to the business as it navigates through these types of arrangements."
Early adoption is permitted, including adoption in any interim period. "This standard is good for early adoption, especially if a private company is concerned with the disconnect between a service arrangement versus buying an internal-use software license, because it does result in what some believe is better balance sheet and income statement presentation," Chiriatti said. Morris agrees that early adoption is a good idea if it makes sense for the company, and planning for that helps make sure companies allow the necessary preparation time for compliance.
About the author
Ellen Goldstein is the Association's director—Communications & Special Projects. To comment on this article or to suggest an idea for another article, contact her at Ellen.Goldstein@aicpa-cima.com.
- "FASB Simplifies Accounting for Cloud Computing Service Costs," JofA, Aug. 29, 2018
- Annual Update for Accountants and Auditors (#730795, text; #153680, online access)
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