New Cloud Computing Accounting GuidanceThe Financial Accounting Standards Board (FASB) has issued new guidance on how to account for implementationcosts related to cloud computing or hosting arrangements. This can include software as a service, platform as aservice or infrastructure as a service. Under the new rules, entities are required to capitalize certainimplementation costs for cloud computing arrangements using the guidance in Accounting Standards Codification(ASC) 350-40, Intangibles—Goodwill and Other—Internal-Use Software.This new accounting rule is an unusual departure from current generally accepted accounting principles (GAAP),since the costs to be capitalized do not relate to the corresponding recognition of a tangible or intangible asset.However, FASB concluded that while the right to receive hosting services and the obligation to pay for thoseservices are not recognized on the balance sheet, certain cloud computing implementation costs enhance theunrecognized right to receive the related service. These amendments align cost capitalization guidance for hostingarrangements that are service contracts, hosting arrangements that include a software license and the costsincurred to develop or obtain internal-use software.These changes are effective for 2020 financial statements for public business entities and 2021 financialstatements for all other entities. Early adoption is available immediately for all entities.Accounting for hosting fees remains unchanged—the fees are expensed as the service is performed.Although the accounting for implementation costs has been standardized, the accounting for the hosting feeswill not be consistent. In a cloud arrangement that includes a software license, the hosting fees attributable tothe software license must be capitalized as an intangible asset with a corresponding liability to the extent thefees are paid over time. In contrast, if a hosting arrangement does not include a software license, the hostingfees are expensed as incurred (see Appendix A).Effective DatesASU 2018-15Cloud ComputingPublic Business EntitiesAnnual and interimreporting periodsbeginning afterDecember 15, 2019All OthersAnnual reportingperiods beginning afterDecember 15, 2020BackgroundFASB first addressed cloud computing costs in 2015 when it issued Accounting Standards Update (ASU) 2015-05,Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid ina Cloud Computing Arrangement, which covered hosting arrangements with a software license. ASU 2015-05amended ASC 350-40 to help entities evaluate whether a hosting arrangement includes an internal-use softwarelicense for accounting purposes. If the hosting arrangement includes a license for internal-use software, thesoftware license is accounted for under ASC 350-40. This generally means an intangible asset is recognized for thesoftware license and—to the extent that the payments attributable to the software license are made over time—aliability also is recognized.If a hosting arrangement does not include a software license, an entity would account for the arrangement as aservice contract. Because existing guidance for hosting service contracts is not explicit, diversity in practice hasarisen. Some costs can be accounted for using existing GAAP, such as the acquisition of hardware or codingchanges to the customer’s on-premise software. Other costs such as customization and configuration of hostedsoftware are not specifically addressed in GAAP and generally are expensed as the services are provided.As more companies migrate from mainframe systems to cloud computing, and given the substantialimplementation costs (that can be as much or more than two to three times the underlying subscription fees),

New Cloud Computing Accounting Guidancecompanies sought additional guidance for arrangements outside of ASU 2015-05’s narrow scope when the hostingarrangement is accounted for as a service contract.ScopeASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accountingfor Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, broadens thescope of ASC 350-40 with an updated definition of a hosting arrangement that removes the reference to licensing(see table below). FASB concluded a customer’s ability to take possession of the software should not be the keydeterminant because the functionality of the underlying software—and the customer’s use—is the sameregardless of whether the software is delivered through the cloud or an on-premise software license. Thecustomer has an economic resource irrespective of ownership or location of the software.All hosting arrangements are now considered to have a software element, regardless of whether the arrangementincludes a license.Hosting ArrangementCurrentIn connection with the licensing of software products,an arrangement in which an end-user of the softwaredoes not take possession of the software; rather, thesoftware application resides on the vendor’s or a thirdparty’s hardware, and the customer accesses and usesthe software on an as-needed basis over the internetor via a dedicated line.ASU 2018-15In connection with accessing and using softwareproducts, an arrangement in which the customer ofthe software does not currently have possession ofthe software; rather, the customer accesses and usesthe software on an as-needed basis.Implementation CostsImplementation costs incurred in a hosting arrangement are fees incurred by the customer to get the hostedservice implemented, set up and ready for use. They may include the cost of software licenses acquired for setupand implementation of a hosting arrangement and software upgrade, enhancement and customization activities.Other implementation costs include training, creating or installing an interface, reconfiguring existing systems andreformatting data.Costs are capitalized or expensed depending on the nature of the costs and the project stage during which they areincurred, consistent with costs for internal-use software. Costs to develop or obtain internal-use software thatcannot be capitalized under ASC 350-40, such as training costs and certain data conversion costs, also cannot becapitalized for hosting arrangements. An entity would expense those costs that are incurred in the preliminaryproject and post-implementation-operation stages. Costs incurred for setup fees should be accounted for inaccordance with guidance in ASC 340 on prepaid assets or other relevant guidance. Costs incurred for integrationwith on-premise software, coding and configuration or customization are capitalized as intangible assets. Thosecosts incurred for data conversion and training are expensed as incurred. Any costs for business processreengineering would be accounted for in accordance with ASC 720-45, Other Expenses.PresentationImplementation costs capitalized should be presented in the same line item in the statement of financial positionthat a prepayment of the fees for the associated hosting arrangement would be presented.2

New Cloud Computing Accounting GuidanceAmortizationEntities are required to expense the capitalized implementation costs over the hosting arrangement’s term. Theterm would include the arrangement’s noncancelable period plus periods covered by: An option to extend the arrangement if the customer is reasonably certain to exercise An option to terminate the arrangement if the customer is reasonably certain not to exercise thetermination option The vendor’s option to extend (or not to terminate) the arrangementAn entity shall consider the effects of all of the following when determining or reassessing the hostingarrangement’s term: Obsolescence Technology Competition Other economic factors Rapid changes that may be occurring in the development of hosting arrangements or hosted software Significant implementation costs that are expected to have significant economic value for the entity whenthe option to extend or terminate the hosting arrangement becomes exercisableAmortization should begin when the module or component of the hosting arrangement is ready for its intendeduse, regardless of whether the overall hosting arrangement will be placed in service in planned stages that mayextend beyond a reporting period. A module is ready for its intended use after all substantial testing is completed.If the functionality of a module is entirely dependent on the completion of other modules, the entity shall beginamortizing the capitalized implementation costs related to that module when both that module and the othermodules upon which it is functionally dependent are ready for their intended use.An entity should use a straight-line basis unless another systematic and rational basis is more representative of thepattern in which the entity expects to benefit from access to the hosted software. The right to access the hostedsoftware is considered equivalent to actual use, which shall not be affected by the extent to which the entityuses—or the expectations about the entity’s use of—the hosted software, i.e., number of transactions processedor expected to process or number of users or expected users of the hosted software.PresentationThe amortization expense should be presented in the same income statement line item as the hostingarrangement expense; it should not be presented along with depreciation or amortization expense related toproperty, plant and equipment and intangible assets. This is because the asset recognized for the implementationcosts is recognized only as a result of enhancing the value of the hosting service, which itself is not recognized asan asset.Unit of AccountThe ASU identifies the unit of account in a hosting arrangement for amortization, impairment and abandonment asa component or module. Consider an accounting software system that contains three elements: a general ledger,an accounts payable subledger and an accounts receivable subledger. In this example, each element might beviewed as a component or module of the entire accounting software system.3

New Cloud Computing Accounting GuidanceImpairmentImpairment and abandonment should be evaluated using guidance in ASC 350-40, which references theimpairment model in ASC 360-10 on property, plant and equipment. An entity is required to evaluate thecapitalized implementation cost of each module of a hosting arrangement for abandonment. The amendmentsrelated to abandonment require that a loss be recorded for capitalized implementation costs that no longerprovide a future benefit in cases in which a module is no longer used while the core hosted software continues tobe used. The guidance is applicable, for example, when one of the following events or changes in circumstancesoccurs related to the hosting arrangement that is a service contract indicating that the carrying amount of therelated implementation costs may not be recoverable: The hosting arrangement is not expected to provide substantive service potential A significant change occurs in the extent or manner in which the hosting arrangement is used or isexpected to be used A significant change is made or will be made to the hosting arrangementDisclosuresFASB concluded the existing disclosures provide sufficient information to users about implementation costs of ahosting arrangement that is a service contract, supplemented by a description of the nature of an entity’s hostingarrangements that are service contracts. ASC 350-40 references other existing authoritative literature, includingthe following: ASC 275 – Presentation, Risks and Uncertainties ASC 730-10 – Expenses, Research and Development ASC 235 – Presentation, Notes to the Financial Statements ASC 360-10 – Property, Plant and Equipment. These disclosures should be made as if the capitalizedimplementation costs were a separate major class of depreciable assetThose topics and subtopics require the following disclosures: Significant estimates to the extent that, based on known information, it is reasonably possible theestimate will change in the near term and the effect of the change will be material, i.e., impairment,change in useful life Total research and development costs charged to expense A description of significant accounting policies and the methods of applying those principles thatmaterially affect the determination of financial position, cash flows or results of operations, e.g.,amortization method Information related to depreciable assets, including: Depreciation expense for the periodBalances of major classes of depreciable assetsAccumulated depreciation, either by major classes of depreciable assets or in total, at thebalance sheet dateA general description of the method or methods used in computing depreciation with respect tomajor classes of depreciable assetsInformation related to impairment of long-lived assets4

New Cloud Computing Accounting GuidanceTransitionThese amendments can be applied prospectively or retrospectively. Under a prospective transition, an entitywould apply the guidance to any cost for implementation performed after the adoption date. An entity maychoose retrospective adoption if it had significant implementation costs during the comparative periods presentedin the financial statements.An entity’s required transition disclosures will depend on the adoption method chosen. All entities must disclosethe nature and reason for the accounting change, the transition method and a qualitative description of thefinancial statement line items affected by the change. For a retrospective transition, an entity also would disclosethe quantitative effects of the accounting change.ContributorAnne [email protected]

New Cloud Computing Accounting GuidanceAppendix AThe GAAP differences related to the hosting fees between hosting arrangements that include a software licenseand hosting arrangements that are considered service contracts are illustrated in the table below.Accounting TreatmentTreatment ofimplementationcostsBalance SheetIncome StatementStatement of CashFlowsInternal use softwareHosting arrangement thatincludes a software licenseHosting arrangement that isconsidered a servicecontractASC 350-40ASC 350-40ASC 350-40Intangible assetIntangible assetLiability (unpaidamounts)Liability (unless fully paid atinitial asset recognition)N/A, or prepaid asset(accrued expense)depending on timing ofpayments in relation to theserviceAmortization expensefor the intangible assetAmortization expense for theintangible assetInterest accretion on theliabilityInterest accretion on theliabilityInvesting outflows (forprepayments)Investing outflows (forprepayments)Financing outflows(principal) and generallyoperating outflows(interest)Financing outflows (principal)and generally operatingoutflows (interest)Operating expenseOperating outflows6

accordance with guidance in ASC 340 on prepaid assets or other relevant guidance. Costs incurred for integration with on-premise software, coding and configuration or customization are capitalized as intangible assets. Those costs incurred for data conversion and training are expensed as incurred. Any costs for business process