In recent times our working world has become more innovative, digitalised and connected. With this has come an increase in the use of cloud computing arrangements. Accounting for cloud computing arrangements is known to be complex. This has caused the topic to be on the IFRIC¹ agenda twice in the last two years. For this reason and due to recent changes in US GAAP, accounting and implementation costs of cloud computing is on top of mind for organisations.
Cloud computing is a technology that allows an organisation to store its servers and data off premise in secure data centres that users can access through the internet. In a cloud computing arrangement, the customer does not currently have possession of the underlying software used in the arrangement. Rather, the customer accesses and uses the software on an as-needed basis. The three common types of cloud computing arrangements are Infrastructure as a Service (IaaS), Platform as a Service (PaaS), and Software as a Service (SaaS).
What needs to be evaluated?
Two IFRIC agenda decisions have been published - one in March 2019 and the other in March 2021 – which will help organisations address certain key questions with regard to accounting for cloud computing. The agenda decision published in the March 2019 IFRIC update has clarified the specific circumstances in which costs associated with cloud computing arrangements can be capitalised either as a lease or as an intangible asset. In practice, it is more common for cloud computing arrangements to not meet IFRIC’s capitalisation criteria.
As a starting point, an organisation must evaluate whether a cloud computing arrangement contains a lease. This they can do by assessing if the arrangement includes the right to obtain substantially all the economic benefits from the use of an asset and the right to direct the use of that asset.
Next, an organisation must evaluate whether a cloud computing arrangement is an intangible asset by determining if the customer receives an economic resource over which it can demonstrate control. If the cloud computing arrangement does not provide the customer with an intangible asset for the software and does not contain a lease, the right to access the underlying software in the cloud computing arrangement is generally a service contract.
Where an organisation recognises an intangible asset, they must evaluate whether to expense or capitalise certain implementation costs using the guidance in IAS 38². The agenda decision published as an addendum to the March 2021 IFRIC Update has addressed whether these implementation costs could be capitalised along with the SaaS arrangement. The decision indicates that SaaS configuration and customisation costs will often be an operating expense. It addresses how such expenses should be accounted for. This has led some organisations to change their accounting policies and, in some cases, write off significant amount of costs which had previously been capitalised.
Where will the impact be?
The changes arising from this IFRIC decision will require careful stakeholder management for organisations. We envisage that navigating these changes may have some knock-on impacts such as:
- Impact on EBITDA and other performance measures;
- Write-offs and reclassifications of previously capitalised assets;
- Impact on debt, borrowing and covenants where items which were expected to be capitalised are required to be expensed;
Some organisations are pausing projects while they are trying to assess the impact. A pause in itself has the potential to cause issues where costs have been capitalised under IAS 38.