FASB Amends Guidance on Cloud
by Elena Cilenti and Chris Chiriatti, Deloitte & Touche LLP
On August 29, 2018, the FASB issued ASU 2018-15,1 which amends ASC 350-402 to address a
customer’s accounting for implementation costs incurred in a cloud computing arrangement
(CCA) that is a service contract. ASU 2018-15 aligns the accounting for costs incurred to
implement a CCA that is a service arrangement with the guidance on capitalizing costs
associated with developing or obtaining internal-use software. Specifically, the ASU amends
ASC 350 to include in its scope implementation costs of a CCA that is a service contract and
clarifies that a customer should apply ASC 350-40 to determine which implementation costs
should be capitalized in a CCA that is considered a service contract. ASU 2018-15 is based on
the consensus-for-exposure that the Emerging Issues Task Force (EITF) reached at its January
2018 meeting, which was further deliberated by the EITF at its June 7, 2018, meeting, where
the Task Force reached a final consensus for issuance of ASU 2018-15 (see Deloitte’s June
2018 EITF Snapshot).
Key Provisions of ASU 2018-15
A Customer’s Accounting for Implementation Costs in a CCA That Is a
ASU 2018-15 aligns a customer’s accounting for implementation costs incurred in a CCA that
is a service contract with the requirements for capitalizing implementation costs incurred
to develop or obtain internal-use software (and hosting arrangements that include an
internal-use software license). Under ASU 2018-15, an entity would apply ASC 350-40 to
determine which implementation costs related to a hosting arrangement that is a service
contract should be capitalized. For example, while an entity would expense costs incurred in
the preliminary-project and post-implementation-operation stages, it would capitalize certain
costs incurred during the application-development stage, and it might be able to capitalize
certain costs during the post-implementation-operation stage that result in enhanced
functionality to the hosted solution. ASU 2018-15 does not change the accounting for the
service component of a CCA.
Connecting the Dots
ASU 2018-15 amends the definition of “hosting arrangement” in the ASC master
glossary by (1) removing the reference to licensing, (2) eliminating the requirement
for the software to reside on the vendor’s or a third party’s hardware, and
(3) replacing the phrase “does not take possession” with “does not currently have
possession.” The Board indicated in the Background Information and Basis for
Conclusions of the ASU that the initial definition of hosting arrangements may
have limited the number of arrangements that could apply this guidance. Common
examples of hosting arrangements include software as a service, platform or
infrastructure as a service, and other similar types of hosting arrangements.
Presentation and Measurement of Capitalized Implementation Costs in a
CCA That Is a Service Contract
Capitalized implementation costs related to a CCA that is a service contract are different from
capitalized costs associated with developing or obtaining internal-use software. Internal-use
software is, by its nature, a recognizable intangible asset. Accordingly, any incurred and
capitalized costs associated with developing or obtaining internal-use software form part of
the acquired asset and would generally also be considered an intangible asset. However, a
CCA that is a service contract does not give rise to a recognizable intangible asset because it is
an executory service contract. Consequently, any costs incurred to implement a CCA that is a
service contract would not be capitalized as an intangible asset (since they do not form part of
an intangible asset) but instead would be characterized in a company’s financial statements in
the same manner as other service costs and assets related to service contracts (e.g., prepaid
expense). That is, these costs would be capitalized as part of the service contract, and financial
statement presentation of the cash flows, the resulting asset, and related amortization would
be consistent with the ongoing periodic costs of the underlying CCA.
Connecting the Dots
ASU 2018-15 aligns the accounting for recognition of implementation costs incurred
in connection with a CCA with the accounting for costs incurred to implement an
internal-use software solution. However, because a CCA may be a service contract
while an internal-use software solution gives rise to a software intangible asset, there
are likely to be differences in the presentation of amortization of the capitalized
implementation costs. The ASU indicates the following regarding the presentation of
implementation costs capitalized in a CCA that is a service contract:
The expense and the fee associated with the hosting arrangement would be
presented as a single line item in the statement of income.
The balance sheet line item for the customer’s presentation of capitalized
implementation costs should be the same as that for the prepayment of fees
related to the hosting arrangement.
The manner in which a customer classifies the cash flows related to
capitalized implementation costs should be the same as that in which it
classifies the cash flows for the fees related to the hosting arrangement.
The ASU specifies that an entity would be required to amortize capitalized implementation
costs over the term of the hosting arrangement “on a straight-line basis unless another
systematic and rational basis is more representative of the pattern in which the entity expects
to benefit from access to the hosted software.” The term of the hosting arrangement should
include the fixed noncancellable periods plus renewal periods the customer is reasonably
certain to exercise, termination periods the customer is reasonably certain to not exercise,
and periods covered by an option to extend (or not to terminate) that is controlled by the
vendor. A customer should consider a number of factors in determining whether to include
optional periods in the term of the CCA, including obsolescence, technology, competition,
economic conditions, rapid changes in the development of hosting arrangements or hosted
software, and the significance of the implementation costs whose economic value is expected
to be substantial when extension or termination options become exercisable. Amortization
of capitalized implementation costs should begin when each module or component of a
hosting arrangement is ready for its intended use, even if the overall hosting arrangement
will be placed in service in planned stages over multiple reporting periods. If the functionality
of a module or component is entirely dependent on the completion of other modules or
components, amortization of capitalized implementation costs would commence when
both the module or component, and the module or component upon which functionality is
dependent, are ready for their intended use.
Connecting the Dots
The EITF discussed whether adding a definition or description of “implementation
costs” would be helpful to preparers but decided that ASC 350-40 already contains
sufficient explanatory guidance.
Application of the ASC 350-40 Impairment Model to Capitalized
Implementation Costs in a CCA That Is a Service Contract
In a manner consistent with ASC 350-40, ASU 2018-15 requires an entity to apply the
impairment model in ASC 360-10-35 to its capitalized implementation costs of a hosting
arrangement that is a service contract. That is, a customer assesses impairment at the
asset grouping level (i.e., the lowest level of separately identifiable cash flows that are largely
independent of the cash flow of other groups of assets). The ASU provides examples of
circumstances in which capitalized costs associated with a CCA that is a service contract may
not be recoverable:
The hosting arrangement is not expected to provide substantive service potential.
A significant change occurs in the manner in which or the extent to which the hosting
arrangement is used or expected to be used.
The hosting arrangement has had, or will have, a significant change made to it.
At its June 2018 meeting, the EITF clarified that an entity might include assets other than the
capitalized costs associated with a CCA that is a service contract when identifying an asset
group for potential impairment. However, when applying the impairment guidance, the
customer would consider the asset related to each module or component of the hosting arrangement as the unit of account for abandonment. That is, the customer should account
for the capitalized implementation costs as abandoned when an entity ceases to use the
related component or module and should evaluate each component or module of a hosting
arrangement separately in determining when cease of use occurs.
Disclosures for Hosting Arrangements That Are Service Contracts
The ASU does not expand on existing disclosure requirements except to require a description
of the nature of hosting arrangements that are service contracts. An entity would therefore
disclose the following for hosting arrangements that are service contracts:
The nature of its arrangements.
The information currently required by ASC 350-40, which does not contain specific
disclosure requirements but instead refers users to other relevant guidance in U.S.
The required disclosures in ASC 360-10 by treating the capitalized implementation
costs as a separate major class of depreciable asset.
Connecting the Dots
Under the guidance in the proposed ASU,3 new disclosures would have
been required for hosting arrangements that are service contracts, and
those requirements would have applied to other transactions within the
scope of ASC 350-40. However, as noted in the Basis for Conclusions of ASU
2018-15, the EITF reached a consensus that the existing disclosures in ASC
350-40 are sufficient.
Effective Date and Transition
The effective dates of the ASU’s amendments are as follows:
Public business entities — Fiscal years beginning after December 15, 2019, and interim
periods within those fiscal years beginning after December 15, 2019.
All other entities — Fiscal years beginning after December 15, 2020, and interim periods
within fiscal years beginning after December 15, 2021.
The guidance may be early adopted in any annual or interim period for which financial
statements have not yet been issued or made available for issuance.
Entities are permitted to apply either a retrospective or prospective transition approach to
adopt the guidance. When prospective transition is chosen, entities must apply the transition
requirements to any eligible costs incurred after adoption.
FASB Proposed Accounting Standards Update, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing
Arrangement That Is a Service Contract: Disclosures for Implementation Costs Incurred for Internal-Use Software and Cloud Computing