The treatment of cloud computing arrangements has been an accounting hot-topic for a number of years. Companies are understandably wanting to capitalise and spread the expense of significant long-term investments in technology, however, accounting standards typically expense services as they are incurred. Therefore, cloud arrangements such as Software as a Service (SaaS) present an accounting challenge.
How are SaaS arrangements and related implementation costs accounted under International Financial Reporting Standard (IFRS)?
Until 2021, there was diverse accounting treatment between different companies for similar SaaS related costs, as the existing IFRS standards did not contain explicit guidance on application of IAS 38 Intangible Assets (IAS 38) to SaaS arrangements – both the licence and related implementation costs.
As a result, the IFRS Interpretations Committee (IFRIC) has issued two agenda decisions clarifying accounting for SaaS arrangements and related implementation costs.
IFRIC’s March 2019 agenda decision – a software intangible asset or a service contract
If a customer obtains control (discussed in the next section) over the underlying software, then all eligible directly attributable implementation costs are capitalised with the intangible software asset as per IAS 38. Certain costs, e.g. training, or associated finance transformation programmes, are never eligible to be capitalised.
IFRIC’s March 2021 agenda decision – accounting for configuration and customisation costs in a cloud service contract
In our experience, most implementation activities could generally be performed by third parties other than the cloud vendor. Where the implementation services are provided by the system vendor, the customer assesses whether the implementation services provided are distinct from access to software by applying the principles in IFRS 15 Revenue from Contracts with Customers (IFRS 15).
Implementation services are not distinct
The customer expenses the implementation costs as access to the software is received, i.e., over the cloud contract term.
The customer recognises a prepayment asset for an advance payment towards the implementation costs.
Implementation services are distinct
When the implementation services are distinct from access to the software, the customer assesses whether the implementation costs represent an intangible asset in its own right that can be capitalised as per IAS 38.
In practice, we would expect management to perform a line-by-line analysis of all implementation costs to determine if any of the costs can be capitalised as an intangible in their own right, e.g., customisation, interfaces and bespoke coding that you control.
If not, expense the implementation costs as the implementation services are received.
Do you ‘control’ the underlying software in a SaaS arrangement?
Generally, you control the underlying software if you can obtain all the benefits from the software without the cloud vendor hosting it or restrict others from obtaining those benefits from the software.
Key indicators to assess your control on the software:
- Do you have the right to move the software on-premises or on to a third party’s infrastructure? (or)
- Do you have exclusivity or ownership of the software? i.e., the vendor cannot make the software available to other customers.
Key practical considerations include:
- Can you demonstrate the costs to move the software on-premise are sufficiently low, that the option to switch is substantive? For example, do you have to make a penalty payment to the vendor, or incur significant incremental costs if you decide to move the cloud arrangement in-house?
- Will there be a significant loss in functionality to move the software on-premises?
- Do you have the availability of qualified IT personnel to manage the implementation, transition the cloud modules?
- Are adequate third-party cloud vendors available in the relevant market to provide the services provided by your existing cloud vendor?
- Are you time restricted in moving the software on-premises, e.g., specific times during the cloud contract or on occurrence of pre-defined events?
- Can you demonstrate the benefits that you would obtain by moving the software on-premises?
- Would there be prohibitive disruption arising from cloud to on-premise?
What do you need to consider before entering into SaaS arrangement?
- Cloud projects are often very material. It is critical to consider well ahead whether the arrangements achieve your accounting objectives.
- If your preference is to capitalise implementation costs, then at the contact negotiation stage, it is important to consider the relevant control rights – e.g., exclusivity over the software, ability to move the software in-house, and nature of related costs. In our experience, control is often differently interpreted by the cloud vendor as compared to the accounting requirements.
- If you are involved in M&A transactions, often the value of a business is based on metrics such as operating profit, EBITDA. The impact of capitalising implementation costs on key metrics should be considered.
- Involve your auditors to sign-off at an early stage if you are looking to capitalise implementation costs, as this is a highly judgemental area.
How can we help?
We are supporting companies with this assessment by:
- Reviewing contracts and control rights to consider if they support capitalisation.
- Drafting technical accounting papers to assess contracts against the guidance, document judgements and articulate to auditors.
- Draft internal accounting policies/manuals, and provide training.
- Hold workshops with finance and IT teams to work through the guidance and the arrangement.
