On April 15, 2015, FASB issued Accounting Standards Update 2015-05, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, as part of its simplification initiative to reduce the diversity in practice, and to reduce the costs and complexity of assessing fees paid in a cloud computing arrangement (CCA).
The new accounting standard does not give explicit guidance on how to account for fees paid in connection with a CCA, rather it provides criteria to determine whether a CCA contains a software license or is solely a service contract. Additionally, the accounting standard also provides guidance on which existing accounting model should be applied. The existing authoritative guidance does not include explicit guidance about a customer’s accounting for fees paid in a CCA, and thus has resulted in diversity in practice as to whether such fees are recorded as a software license or a service contract. This has further resulted in unnecessary costs and complexity for some stakeholders to evaluate the accounting for those fees.
Examples of cloud computing arrangements include software as a service, platform as a service, infrastructure as a service and other similar hosting arrangements. “Hosting” refers to an arrangement in which the end user does not take possession of the software; instead, the software resides on the vendor’s or a third party’s hardware, and the customer accesses the software remotely over the Internet.
This new guidance provides a basis for evaluating whether a CCA includes a software license. The new guidance applies only to internal-use software that a customer obtains access to in a hosting arrangement. Internal-use software guidance would be applied if both of the following criteria are met:
- The customer has the contractual right to take possession of the software at any time during the CCA period without significant penalty.
- It is feasible for the customer to run the software on its own hardware or contract with another party unrelated to the vendor to host the software.
Arrangements that meet both of these criteria are considered multiple-element arrangements to purchase both a software license and a service of hosting the software. Existing guidance on internal-use software is applied to the purchased license. Arrangements that do not meet both of these criteria are considered service contracts, and separate accounting for a license will not be permitted. The amendments in the new accounting standard do not change the treatment for a customer’s accounting for service contracts.
The standard provides some guidance on how to interpret the term “without significant penalty.” The standard refers to this term as the ability to take delivery of the software without incurring significant cost and to use that software separately without a significant reduction in value.
- The ability to take delivery of the software without incurring significant cost.
- The ability to use the software separately without a significant decrease in value.
Some CCA’s may include one or more licenses to software as well as other services to be provided to the customer. The customer should allocate the contract consideration between the license(s) and the service element(s) based on its relative fair value of each element. Determining the fair value of the software license and hosting service may require the use of estimates.
The new guidance also eliminates the requirement of organizations to analogize to Topic 840, Leases, when making the determination if an asset acquired is a license of internal-use software. Eliminating this analogy to the leasing guidance requires an organization to follow the same guidance for capitalization as other licensed intangible assets, which provides consistency with the accounting treatment between licenses of internal-use software and other licenses of intangible assets.
There are other accounting implications with this new accounting standard, such as the accounting for upfront fees associated with a CCA. The accounting treatment of upfront fees on a CCA are contingent on whether fees paid are for a payment for a software license or a prepayment for a service contract. Below is an graph to illustrate this accounting treatment.
Due to the nature of how the accounting standard will require the presentation of some CCA’s to be split between a fixed asset and a service contract, universities should be very mindful in the future as it pertains to the budgeting and tracking of these costs, specifically between a typical educational/general budget and a capital budget.
This new standard is effective for non-profit universities for periods beginning after December 15, 2015. All entities should make disclosures for prospective transition or retrospective transition, as applicable, in the first annual period after the adoption date. Early adoption is permitted.
GASB currently does not have any requirement for capitalization of software systems purchased, although this is being considered as part of a project focused on intangible assets. NACUBO’s advisory board on this subject recommends that public institutions follow the same guidance as independent institutions.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
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