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Proposed Amendment to U.S. GAAP Allows Capitalization of More Cloud Computing Costs

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

The FASB released for public comment a proposed amendment to U.S. GAAP developed by its Emerging Issues Task Force (EITF) to clarify the accounting for the costs associated with setting up business software packages that are managed in the cloud. If finalized the proposed amendment to U.S. GAAP would let more of the costs arising from implementing a cloud computing contract be spread over the contract’s life.

The FASB published Proposed Accounting Standards Update (ASU) No. 2018-230, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract; Disclosures for Implementation Costs Incurred for Internal-Use Software and Cloud Computing Arrangements — a Consensus of the FASB Emerging Issues Task Force, on March 1, 2018.

The accounting board wants comments submitted by April 30. The FASB said the effective date for the proposed changes will be determined once its Emerging Issues Task Force (EITF) has an opportunity to review the feedback submitted in response to it.

The proposal was issued to clarify the financial reporting for the implementation costs of a cloud computing arrangement that is a service contract, the FASB said. The proposal seeks to align the requirements for capitalizing the implementation costs for a hosting arrangement that is a service contract with the requirements for capitalizing the implementation costs from developing or obtaining software that a company runs on its servers or servers operated by a third party. The accounting for the service element of the hosting arrangement would not be affected by the proposed amendments.

If the proposed changes are issued as a final update to U.S. GAAP, a customer in a cloud computing contract would have to include in the footnotes to its financial statements information about the software it purchases, including the systems it runs on its servers, has hosted by a third-party provider, or obtains via a cloud computing contract.

If the proposed guidance is finalized, it will address an issue that has been overlooked in U.S. GAAP — what to do with the implementation costs for setting up a hosting arrangement.

Proposed ASU No. 2018-230 instructs financial reporting professionals to refer to FASB ASC 350-40, Intangibles — Goodwill and Other — Internal-Use Software, to determine which implementation costs in a cloud computing arrangement that is considered a service contract can be capitalized as an asset. The costs that can be capitalized will be treated as long-term assets and amortized over the life of the arrangement and not booked as an expense at the contract’s outset.

The expenses for developing or obtaining internal-use software that cannot be capitalized according to FASB ASC 350-40, such as the costs for training and data conversion, also would not be capitalized for a hosting arrangement that is a service contract. The business or organization that is the customer in the hosting arrangement would determine which stage of project an implementation activity relates to. The implementation costs at the application development stage would be capitalized depending on their nature. But the costs that are incurred during the preliminary project and postimplementation stages would be expensed as the activities are performed.

The EITF agreed to issue the proposal in January, and the FASB endorsed the task force’s decision on February 7.

The proposal amends the definition of the term “hosting arrangement” in the Master Glossary for the FASB’s Codification by replacing the word “licensing” with the words “accessing and using” with regard to the use of a software application.

FASB ASC 350-40 provides guidance about the accounting for software that a business develops or obtains for internal use. In 2015, the FASB published ASU No. 2015-05, Intangibles—Goodwill and Other— Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, to update the guidance with the goal of helping businesses evaluate whether a hosting arrangement includes an internal-use software license. When a hosting arrangement does not include a software license, the arrangement must be accounted for as a service contract, which means businesses must expense the costs as incurred.

But questions from businesses persisted, especially as more companies reject servers that are installed at their premises and set up cloud-based solutions for common business applications. The costs to set up the cloud services are often significant, and many companies see no economic difference between a contract that includes a license to run the software locally versus a contract to have the application run on the cloud. Businesses also prefer to not to have to report big expenses — up to hundreds of millions of dollars — in the period they set up the arrangements.

The amendments in ASU No. 2015-05 did not address the accounting for the costs incurred to implement a hosting arrangement that is a service contract. Many businesses told the FASB they did not see the difference between the two types of contracts, and they should be allowed similar accounting treatment.

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