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The benefits of cloud computing are considerable, and recent accounting changes have made cloud solutions even more attractive to many businesses. On August 29, 2018, the FASB issued new guidance on a customer's accounting for implementation, set-up and other upfront costs incurred in a cloud computing arrangement (CCA) hosted by the vendor—that is, a service contract. Under the new guidance, a customer will apply the same criteria for capitalizing implementation costs of a CCA as it would for an on-premises software license.
Moving data, applications and platforms to the cloud may create substantial business benefits because companies may be able to reduce capital expense outlays while maintaining a more flexible IT environment. However, companies should consider the financial reporting implications as well as broader tax and IT considerations as a result of the new accounting guidance.
Video: Moving IT solutions to the cloud? Consider the financial reporting as well as the broader tax and IT considerations resulting from the new cloud computing guidance.
|Capital outlays for hardware & applications||Yes||No|
|Flexible IT infrastructure||No||Yes|
|Customer’s costs categorization||Capital–No impact to EBITDA||Operating–Reduces EBITDA|
 Earnings before interest, tax, depreciation, and amortization
Here’s a quick comparison of what has changed, comparing the previous standard to the new guidance:
 Accounting Standards Update (ASU) 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement
If the CCA includes a software license, under the old guidance, the license is within the scope of the internal-use software guidance. This addresses which costs should be capitalized, including the cost to acquire the license and the related implementation costs.
If the CCA does not include a software license, the arrangement is a service contract, and the fees for the CCA are recorded in the same way as other SaaS expenses, generally as operating expense. The previous guidance does not specifically address the accounting for implementation costs related to a service contract.
The new guidance clarifies that implementation costs, including CCAs that do not transfer a software license, may qualify for capitalization based on the phase and nature of the costs.
|Potentially capitalizable||Generally not capitalizable|
|External direct costs of materials||Costs for data conversion activities|
|Third-party service fees to develop the software||Costs for training activities|
|Costs to obtain software from third-parties||Software maintenance costs|
|Coding and testing fees directly related to software product|
Also see PwC’s “In depth” guidance — Cloud computing arrangements: Customer accounting for implementation costs.
Key challenges in accounting for software investments stem from the changes in software development practices. Previously, a linear or “waterfall” method typically involved a sequential software design process that “flowed” steadily downwards through lengthy development phases. Accounting for investments in linear/waterfall development methods was relatively straightforward, compared to today’s environment.
Current technology and software development processes now largely follow an agile development life cycle. With agile software development, requirements and solutions—including many involving CCA arrangements—evolve through collaboration among self-organizing, cross-functional teams. These methods have many advantages.
However, reconciling agile development and delivery models with outdated financial reporting rules creates complexities:
Determining which operational aspects of CCA software implementation activities are eligible for capitalization requires judgment and an analysis of the nature of the costs incurred. As discussed earlier, this can be particularly challenging in an agile environment. Here are some of the operational challenges that could influence whether implementation activities are eligible for capitalization, which must be addressed.
|Process and control challenges||Actions to consider|
|Determining which activities qualify for capitalization versus expense treatment||
|Addressing operational complexities that may arise from agile software development||
|Assessing the accounting for implementation costs for CCAs with multiple modules or components||
Evaluating CCA service provider arrangements to determine which fees represent implementation costs
|Assessing cross-functional arrangements||
To assist in addressing these challenges, companies can use this as an opportunity to leverage technology through process automation. Visualization tools can be used to simplify and track the end-to-end process of CCA for data already captured today, or tracked specifically for project purposes. By leveraging existing technology and embracing process automation, business decisions can be made quicker, with real-time information, leading to more efficient processes and comprehensive outcomes related to accounting treatments and technology solutions.
Additionally, a cloud computing contract may require application of multiple accounting standards—many of which have also recently changed. In these situations, companies need to consider whether costs, which would otherwise have been within the scope of the updated cloud computing standard, are accounted for using a different standard. For example, if a CCA includes an explicit or embedded lease (e.g. dedicated equipment/servers), the company would need to determine which costs are accounted for under ASC 842, versus the new cloud computing standard.
Many companies have also been implementing the new revenue recognition and lease accounting standards. As part of this journey, many are exploring technology solutions including CCA to automate and optimize. A CCA can facilitate implementation of accounting changes and create significant efficiencies.
It’s important to understand that the new cloud computing standard could significantly impact the recognition of costs for the implementation. Additionally, incorporating new automation systems requires a front-loaded investment to select new systems and get them up and running.
To the extent that companies are implementing a CCA as part of other accounting change initiatives, they should also ensure they have the right processes and governance to address the new CCA standard.
The new cloud computing guidance creates an opportunity to enhance tax processes and increase tax positions around these costs. As the nature of the CCA costs incurred will dictate treatment for both tax and book purposes, the new standard can also be an opportunity to create synergies related to data gathering around such positions. Key tax areas of analysis include:
PwC has deep expertise in implementing financial reporting changes. Our teams can assist with financial reporting questions, as well as the broader business implications. The assistance we can provide includes:
Contact one of our professionals to have a deeper conversation about your organization’s challenges with recent accounting changes and how we can be of assistance.