The costs to set up cloud computing services can be significant, and many companies would prefer not to immediately expense these setup costs. Updated guidance on accounting for cloud computing costs aims to reduce differences in the accounting treatment for these arrangements. In a nutshell, the changes will spread more of the costs of implementing a cloud computing contract over the contract’s life than under existing guidance.

Old rules

Accounting Standards Update (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, differentiated between agreements involving a software license and those involving a hosted service. However, it didn’t discuss how to record the associated implementation costs, which lead to differences in the accounting treatment.

Under ASU 2015-05, when a cloud computing arrangement doesn’t include a software license, the arrangement must be accounted for as a service contract. This means businesses must expense the costs as incurred.

On the other hand, when an arrangement does include such a license, the customer must account for the software license by recognizing an intangible asset. To the extent that the payments attributable to the software license are made over time, a liability is also recognized.

New rules

ASU 2018-15, 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, instructs companies to apply the same approach to the capitalization of implementation costs associated with the adoption of a cloud computing agreement and an on-premises software license.

When companies implement ASU 2018-15, they can capitalize and amortize certain costs associated with the application-development phase over the duration of the hosting arrangement. However, companies should expense costs incurred during the preliminary project and post-implementation phases.

Implementation guidance

Implementing the updated guidance will require the following steps:

Identify cloud computing arrangements. Each line of business, as well as the supply chain management and payables departments, should be instructed to notify the accounting department of any new cloud computing agreements.

Decide whether to capitalize or expense implementation costs. ASU 2018-15 requires that companies follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset and which to expense.

Forecast the financial implications. For each contract, model the impact on your company’s financial statements. Because the standard allows for the deferral of implementation costs vs. expensing the costs as incurred, there will be a corresponding impact on your company’s financial ratios.

Need help?

Public companies must start the implementation process now to ensure compliance for annual reporting periods beginning on or after December 15, 2019. Private companies and nonprofits have an extra year to comply — or they may choose to adopt the changes early to spread more set-up costs over the duration of their contracts. If you’re unsure how to account for cloud computing arrangement, contact us.