Update Guidance for Accounting for Cloud Computing Arrangements

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In August 2018 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2018-15 (ASU 2018-15).  Included in this update is subtopic 350-40 Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.  This subtopic provides guidance on which Cloud Computing Arrangement (CCA) implementation costs should be capitalized as an asset or expensed.  ASU 2018-15 is applicable to public business entities starting in 2020 and all other entities in 2021.  

CCAs, in general, are third-party service contracts.  There are three types of CCAs:

  1. SaaS: Software as a Service - web-based delivery of applications managed by a third-party vendor.

  2. PaaS: Platform as a Service - third-party provided framework for a team of software developers to create and manage customized applications.

  3. IaaS: Infrastructure as a Service - third-party provided on-demand, self-service access to highly scalable and automated computing resources.     

When a CCA is hosted by a vendor, through a service contract, there are certain implementation costs that are capitalizable in a similar way that internal-use software license implementation costs are capitalizable.  There are several business benefits to using a CCA for software needs including reduced capital expense outlays as well as a more flexible information technology (IT) environment for employees. The updated accounting guidance for implementation costs is another business benefit that makes the use of CCAs more attractive to businesses.  

Prior to this update, implementation costs were not addressed; prior guidance distinguished between arrangements including a software license and arrangements only through a CCA hosted service.  The recent update provides balance sheet, income statement and statement of cash flows classification information for the capitalized implementation costs and the associated amortization expense.  The update also provides clarification of any confusion from the previous guidance related to service contract implementation costs.

For CCAs that include a software license, the new guidance details which costs should be capitalized including the cost to acquire the software license and the related implementation cost.  Previous guidance included this software license under internal use software guidance. For CCAs without a software license, they are considered service contracts (as defined as a SaaS above) and the fees are generally recorded as an operating expense.  Previous guidance did not address implementation costs for service contracts with no related software license. The recent update addresses any exceptions to expensing service contract fees which are dependent on the phase and nature of the specific service contract.

As discussed in the update, there are several potentially capitalizable costs:

  1. External direct costs of materials

  2. Third-party service fees to develop software

  3. Cost to obtain the developed software from third party

  4. Coding and testing fees directly related to third-party developed software product

The following are costs that are generally considered non-capitalizable:

  1. Data conversion activities 

  2. Training activities

  3. Software maintenance

As one can expect, subtopic 350-40 details the level of judgment needed as well as the testing requirements to assess which costs are capitalizable.  This article only provides a general overview of the update. The entire accounting update can be found on the FASB website as www.fasb.org.