Final consensus was reached that implementation costs associated with a cloud computing arrangement that is considered a service contract should be evaluated for capitalization using the same model used for such costs related to software licenses.
The Task Force reached a consensus-for-exposure that an acquirer should recognize a liability for a performance obligation in a revenue contract acquired in a business combination using the definition in ASC 606. The exposure document will also include specific examples.
Initial deliberations were held. The Task Force directed the FASB staff to perform additional research on a variety of issues.
The Task Force discussed an unsolicited comment letter about the cash flow classification of cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables. The Task Force recommended the FASB not reconsider this matter.
If ratified by the FASB, the final consensus related to Issue 17-A will be issued as a final Accounting Standards Update (ASU) and the consensus-for-exposure related to Issue 18-A will be issued as a proposed ASU. The Task Force will continue deliberations of Issue 18-B at a future meeting.
Under current GAAP,1 a cloud computing arrangement that contains a license is accounted for consistent with other licenses of internal-use software in accordance with ASC 350-40, Internal-Use Software. Under ASC 350-40, implementation costs incurred in the preliminary and post-implementation phases are expensed, while costs incurred in the application development phase are either expensed or capitalized, depending upon the type of cost. If the cloud computing arrangement does not include a software license, it is accounted for as a service contract. However, if it is a service contract, guidance is unclear as to how to account for the related implementation costs. Consequently, diversity in practice exists.
At the June 2018 meeting, the Task Force reached a final consensus that implementation costs should be capitalized using the same model as if the cloud computing arrangement included a software license. The final consensus is in line, for the most part, with the proposed ASU on the topic issued in March 2018. The Task Force affirmed that preparers should utilize ASC 350-40 to determine which implementation costs are eligible to be deferred based on the project stage and nature of the cost.
The Task Force affirmed that the capitalized implementation costs should be expensed over the term of the hosting arrangement, which includes periods covered by renewal options that are reasonably certain to be exercised. The expense should be presented in the same income statement line item as the fees associated with the hosting arrangement. The Task Force clarified that the capitalized implementation costs should be presented in the same line item on the balance sheet as a prepayment of fees related to the hosting arrangement. On the statement of cash flows, payments for capitalized implementation costs should be classified in the same manner as payments for the hosting arrangement.
The Task Force also affirmed that an entity should apply the impairment model in ASC 350-40 with the clarification that the unit of accounting for abandonment is the asset related to a module of the hosting arrangement. Additionally, the Task Force made minor clarifications to the definition of a hosting arrangement.
In the proposed ASU, incremental disclosures would have been required for all software arrangements. The Task Force ultimately decided that few new disclosures were needed above those already required under existing GAAP. The disclosures will include the nature of the hosting arrangement along with certain information that arguably would be required by ASC 360-10, Property, Plant and Equipment (e.g., quantitative information about the amounts capitalized, amortized and impaired during the period, and significant judgments made in applying the guidance).
Reporting entities will be allowed to choose between prospective and retrospective transition. However, in a change from the proposed ASU, prospective transition would be applied to any eligible costs incurred after the adoption date rather than to new arrangements after the adoption date.
For public business entities, the effective date is fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. All other entities have an additional year. Early adoption is permitted.
1ASU 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement
In March 2018, the Board asked the EITF to address the recognition of a revenue contract with a customer that is acquired in a business combination after an entity has adopted ASC 606, Revenue from Contracts with Customers. Currently, there are diverse views. Some believe that only legal obligations should be recognized as a liability by the acquirer in purchase accounting. Others believe performance obligations, as that term is used in ASC 606, should be recognized. Additionally, the Board directed the FASB staff to provide educational information on measurement questions that may arise when measuring these assumed liabilities.
The Task Force reached a consensus-for-exposure that an acquirer should recognize a liability for a performance obligation in a revenue contract acquired in a business combination using the definition in ASC 606. The concept of a performance obligation is broader than legal obligation because it also includes constructive obligations and obligations for customary business practices. The Task Force decided on a prospective transition method.
The Task Force discussed the educational materials provided by the FASB staff related to measurement. Specifically, the Task Force discussed an example in which a non-exclusive license of symbolic intellectual property (IP) for a character image is sold. Payment is received up-front at the point in time the license is delivered while revenue is recognized over time. The Task Force agreed that the remaining performance obligation should be measured at its acquisition-date fair value in purchase accounting. In other words, it is not appropriate for an acquirer to use the acquiree’s carry-over basis of its deferred revenue in purchase accounting. Rather, the fair value of the performance obligation should consider only the incremental costs to support or maintain the revenue contract and not those costs that an acquirer would incur irrespective of the acquired contract. In many cases, the fair value measurement of the performance obligation will be minimal or zero.
The Task Force also discussed that fair value measurement of the performance obligation would not change if payment for the revenue contract were fixed over time. In these cases, an acquirer should recognize the fair value of the right to receive the remaining consideration from the customer in purchase accounting. This is because the effect on the acquirer’s profit or loss should not be different simply due to differences in timing of the receipt of fixed consideration (other than with respect to the recognition of interest income or other differences between the fair value of the asset recognized and the consideration received).
The Task Force also discussed how direct costs to fulfill a performance obligation should be considered in measuring the liability. The Task Force agreed with the FASB staff’s view that, when an entity determines the fair value of an assumed liability, it should consider the assets and liabilities in the acquired set. For example, when measuring a liability for the arrangement noted above, the acquirer should not include the additional costs for a market participant to purchase the related IP separately because the related IP was also acquired.
In March 2018, the FASB asked the EITF to consider whether the cost capitalization guidance for episodic television series in ASC 926-20, Entertainment-Films, is still appropriate given the changes in the media and entertainment industry since the guidance was originally issued. The Task Force was also asked to consider whether changes to the amortization, impairment, and disclosure requirements in ASC 926-20 were necessary.
Currently, the guidance in ASC 926-20 provides a capitalization model for episodic content that is different than the model for films. Production costs for episodic content are capitalized subject to a constraint based upon contracted revenues in the initial and secondary markets, while film costs are fully capitalized. The internet has changed the business environment in which media is produced and distributed. The changes in distribution models, new participants in the industry and new business models challenge the relevance of the constrained capitalization model for episodic content.
Task Force members tentatively decided to align the cost capitalization guidance for episodic content to the guidance for films by removing the content distinction. This recognizes that business models have changed and the risks associated with producing episodic content have become similar to film content. Therefore, the current guidance does not reflect the economics of episodic content production.
The Task Force agreed not to change the current amortization guidance as it provides for flexibility and judgment, which will allow the model to be relevant even if business practices continue to change.
Task Force members generally supported aligning the impairment models for film costs in ASC 926-20 and licensed content in ASC 920-350, Entertainment-broadcasters. The FASB staff recommended amending the guidance in ASC 926-20 for the unit of account for impairment to be at the lowest level at which identifiable cash flows are largely independent of other assets and liabilities. Additionally, the staff proposed adding additional indicators of impairment at the title level and aligning the impairment models to a fair value model. The Task Force discussed potential issues with the proposed model. Some members observed that having triggers for impairment at the title level may result in entities performing an impairment analysis each reporting period, which would result in additional cost. However, since the lowest level of identifiable cash flows may often be at an aggregate level, there would likely be little to no impairment. Some members were concerned that the proposed model was not clear when entities should reassess useful life of the individual title if there was no impairment recognized.
The Task Force agreed that when an impairment is recognized, the asset should be written down to fair value. The Task Force instructed the staff to perform further outreach on these issues and the related disclosures with the working group.
In August 2016, the FASB issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provided narrow scope improvements to eight specific cash flow issues, which impacted how cash flows related to beneficial interests in securitization transactions should be presented. ASU 2016-15 requires disclosure of a transferor’s beneficial interest obtained in a securitization of financial assets as a noncash activity and the classification of cash receipts from payments on a transferor’s beneficial interest in securitized trade receivables as cash inflows from investing activities.
In February 2018, the FASB received an unsolicited comment letter expressing concerns that an investing activities classification for these types of cash flows would cause the statement of cash flows to be less relevant than a classification in operating activities.
The Task Force did not identify any new information in the letter that was not already considered during its deliberations. Consequently, the Task Force recommended that the FASB not reconsider the conclusion.
The Task Force also discussed an implementation issue related to the application of ASU 2016-15 for securitized trade receivables that involve revolving structures. The FASB will discuss at a future meeting whether the issue should be reconsidered. Refer to In depth 2017-31, Sales of trade receivables get new statement of cash flow treatment for further discussion of this issue.
National Professional Services, PwC US