The Cloud. Most of us use it (or maybe you might find that your head is consistently in the clouds)! Well, good news, my head was also in the clouds this week – so today’s blog is going to discuss cloud computing arrangements, specifically as it relates to implementation costs for service contracts. But before we dive into specifics, let’s take a look at an example.
To support its computer storage needs, Lebron & Kobe Fitness has historically used its own internal server infrastructure. But recently, Lebron & Kobe released a new fitness app, Be Like Mike, that has been hugely successful, so Lebron & Kobe entered into a cloud computing arrangement (CCA) with a hosting company to provide the necessary server space and processing power to support the app. This CCA does not include a software license and is therefore classified as a service contract.
In order to migrate to the cloud, Lebron & Kobe incurred a number of costs, including integration (designing new interfaces), testing, training of Lebron & Kobe’s employees, and converting/reformatting data from the old server. Do you think Lebron & Kobe can capitalize any of these costs? What costs do you think can be expensed?
Current guidance (ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement) states that if a CCA is a service contract, which is what the arrangement is with Lebron & Kobe, then all costs associated with that service contract are generally expensed as incurred. If the CCA includes a software license, then the arrangement falls within the scope of ASC 350-40, Internal-Use Software, which addresses specific costs that can be capitalized. Typically, internal-use software costs are allocated into three stages (preliminary project, application development, post-implementation) and certain costs in the application development stage can be capitalized if certain criteria are met. Therefore, it is important to determine the type of CCA because this will determine whether any costs can be capitalized.
As stated, our example relates to a service contract; therefore, under current guidance, no costs would be capitalized. But that guidance is changing……
In August, the FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which will now allow all CCAs classified as service contracts to capitalize certain implementation costs in accordance with ASC 350-40! So, if Lebron & Kobe were to adopt ASU 2018-15, the integration and testing costs incurred with their migration can be capitalized. The training and conversion costs would be expensed as incurred, because remember – training and conversion costs (not associated with conversion software) are expensed as incurred, regardless of the project stage.
Lebron & Kobe would then be required to amortize (expense) those capitalized costs over the term of the arrangement on a straight-line basis (unless another systematic and rational basis is more representative). ASU 2018-15 states that the term of the arrangement includes the non-cancellable period plus periods covered by:
- an option to extend the arrangement if the customer is reasonably certain to exercise that option,
- an option to terminate the arrangement if the customer is reasonably certain not to exercise the termination option, and
- an option to extend (or not to terminate) the arrangement in which exercise of the option is in the control of the vendor.
Capitalized costs must be evaluated for impairment in accordance with ASC 360-10-35 (long-lived assets). Additionally, if a service arrangement is being terminated early, the capitalized costs should be treated like an asset being disposed of by abandonment in accordance with ASC 360-10-35-7 through 35-49 (expense the capitalized costs when the related host services cease to be used).
ASU 2018-15 would also require Lebron & Kobe to present their capitalized costs as follows:
- Balance sheet: capitalized costs would go to the same line item as amounts prepaid for the hosted CCA service
- Income statement: amortization of capitalized costs would go to the same line item as the fees for the hosted CCA service
- Cash flows: capitalized costs are presented consistent with the fees related to the hosted CCA service
Effective date and transition
The new guidance will be effective for public business entities in fiscal years beginning after December 15, 2019, including interim periods within those years (i.e., in the first quarter of 2020 for calendar year-end companies). For entities other than public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim reporting periods within annual reporting periods beginning after December 15, 2021. Early adoption is permitted, including adoption in any interim period, for all entities.
Entities can choose to adopt prospectively to eligible costs incurred on or after the effective date, or retrospectively to all periods presented. For entities that adopt prospectively, if there is an ongoing implementation project, all costs incurred PRIOR to the beginning of the (interim) period in which the new guidance is adopted are expensed as incurred.
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