Cloud Computing Arrangements For Service Contracts
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.
Service contract scenario
Let’s consider the following scenario:
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?
Accounting for service contracts
Under previous guidance, no costs would’ve been capitalized!
But I’m not worried about the past, I’m worried about the now! And now, all CCAs classified as service contracts are allowed to capitalize certain implementation costs in accordance with ASC 350-40.
So, Lebron & Kobe can capitalize the integration and testing costs incurred with their migration. The training and conversion costs would be expensed as incurred, because 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). 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).
Presentation of capitalized costs
Lebron & Kobe would be required 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
Final thoughts
We hope you found this blog post insightful! U.S. GAAP is always changing and updating, so make sure you check out all of our eLearning courses we have in our U.S. GAAP course library, including all of our annual updates!
Also, who is the GOAT? Lebron or Kobe? My vote is Michael (Be Like Mike)!
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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.
