Update: Configuration and customisation costs in a Cloud Computing Arrangement

The agenda decision includes steps which entities should consider in accounting for such CC costs. The key areas of consideration are as follows:

• Can the costs be capitalised as an intangible asset?
• Can the costs be capitalised as a prepayment, or should the costs be expensed when incurred?

This will impact entities that incur CC costs associated with a Software as a Service (SaaS) cloud arrangement, and might result in a change in accounting policy. Entities should ensure they dedicate sufficient resources to  obtain the historical information about their current and previous SaaS arrangements to implement any change in accounting policy appropriately and on a timely basis.

1. Background

Cloud computing is a model for delivering information technology services through web-based tools and applications. Cloud services usually fall into one of three service models: infrastructure, platform and software. This publication focuses on Software as a Service (SaaS).

In such contracts the customer generally does not obtain a software licence or have a right to take possession of the software. The contract conveys to the customer the right to receive access to the supplier’s application software over the contract term. That right to receive access does not provide the customer with a software asset and, therefore, the access to the software is a service that the customer receives over the contract term. The software typically remains on the seller’s hardware, and the buyer would only access the software via an internet connection.

The IFRS IC issued an agenda decision on the treatment of SaaS arrangements in March 2019. The March 2019 agenda decision considered the accounting for SaaS arrangements as a whole. It indicates when an arrangement would likely be accounted for as a service (which is often the case for cloud computing if the entity does not obtain a right to take possession of the software) versus when it could be an intangible asset or a lease. In the latest agenda decision the IFRS IC has focused solely on the treatment of CC costs. This In Depth therefore focuses on only the accounting for CC costs of such arrangements.

What are CC costs in a Cloud Computing Arrangement?

Many entities will pay a fee for the SaaS arrangement and an additional amount to configure and/or customise those services to their own specific requirements in advance of receiving the services. For example, an entity might have a SaaS arrangement for a human resources system but want to customise it to create additional reporting functionalities. As part of the discussion papers which led to the agenda decision the IASB staff defined CC costs as follows:

(i) Configuration: Typical configuration relates to the setting of various ‘flags’ or ‘switches’ within the software, or defining certain values or parameters, to implement a particular set-up for the software’s existing functionality. Configuration does not involve the modification or writing of additional software code, but rather involves setting up the software’s existing code to function in a particular way for the entity’s benefit.

(ii) Customisation: Typical customisation involves modifying existing software code in the application or writing additional code. The effect of significantly altering or adding software code is generally to change, or create additional, functionalities within the software so that it can provide the intended benefits.

The CC might be performed by the customer themselves, the SaaS provider, or a third party and is often a substantial cost in relation to the total cost of the SaaS arrangement.

This publication covers how to account for these CC costs and if they should be capitalised as an intangible asset or a prepayment in the statement of financial position, or if they are required to be expensed when incurred. There could be a variety of other costs which are incurred as part of the arrangement. An entity will continue to make their usual judgements about how to treat those other costs, for example, development of bridging modules that connect or integrate the SaaS software with existing software/systems controlled by the entity. This publication does not apply to these other costs.

2. Practical issues

Can CC costs in cloud computing arrangements be capitalised?

There are three steps that entities should consider when thinking about CC costs in a SaaS arrangement. The decision tree below summarises the steps:

3. Question 1: Do the CC costs meet the definition of an intangible asset (IAS 38)?

An intangible asset is defined as ‘an identifiable non-monetary asset without physical substance’. An asset is a resource controlled by an entity. An entity controls an asset if it has the power to obtain the future economic benefits from an underlying resource and to restrict the access of others to those benefits.

The Committee observed that, in the SaaS arrangement described in the request, the customer often would not recognise an intangible asset because it does not control the software being configured or customised and those activities do not create an asset that is separate from the software. In some circumstances however, the arrangement may result in, for example, additional code from which the customer has the power to obtain the future economic benefits and to restrict others’ access to those benefits. In that case, the customer assesses whether the additional code is identifiable and meets the recognition criteria in IAS 38 to recognise the additional code as an intangible asset.

If the definition of an intangible asset is met and the SaaS provider or a third party carries out the CC, the intangible asset is not an internally generated intangible asset and qualifies for recognition as a separately acquired intangible asset.

Where an entity carries out the CC themselves and the definition of an intangible asset is met, an assessment about whether costs incurred meet the criteria for capitalisation is required. There are specific criteria which should be met before these costs can be capitalised, the criteria are set out in IAS 38.57 as follows:

‘An intangible asset arising from development (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following:

• the technical feasibility of completing the intangible asset so that it will be available for use or sale.
• its intention to complete the intangible asset and use or sell it.
• its ability to use or sell the intangible asset.
• how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
• the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
• its ability to measure reliably the expenditure attributable to the intangible asset during its development.’

If an entity has concluded that the costs do not meet the definition of an intangible asset, they should assess whether the costs can be capitalised as a prepayment or must be expensed as incurred. IAS 38 requires an entity to expense the cost of a service when it is received. A service is received when it is performed by the supplier in accordance with a contract and not when the entity uses the service.

IAS 38 does not provide any guidance on what ‘performed by the supplier’ means nor does it provide guidance around the identification of services received from a supplier. The IFRS IC suggested entities should look to the criteria in IFRS 15 Revenue from Contracts with Customers to determine the nature of the services which might impact when they are performed by the supplier. An entity should understand who is performing that service (a third party or the SaaS provider) and whether the service is distinct from the SaaS performance obligation following the criteria in IFRS 15 to conclude when the service is performed.

4. Question 2: Are the CC services distinct from the SaaS arrangement?

To determine whether the CC services are distinct from the SaaS arrangement an entity should look to the criteria in IFRS 15. The customisation cost would be recognised over the period of the customisation when the promises are distinct. The customisation costs would be recognised as a prepayment and spread over the entire SaaS arrangement if the promises are not distinct. In some cases making this determination might be challenging because the criteria in IFRS 15 were developed with revenue recognition in mind, rather than cost capitalisation from the customer’s perspective.

Per IFRS 15, a good or service that is promised to a customer is distinct if:

• the customer can benefit from the good or service, either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct); and
• the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).

Therefore, the assessment of whether a good or service is distinct has two elements; the good or service must be both: (a) capable of being distinct; and (b) separately identifiable. [IFRS 15 para 27]

If the CC risk and SaaS service risk are not distinct, then the entity would conclude that it has not yet received the service related to the payment made for the CC. As a result, the payment for the CC would be a prepayment related to the combined SaaS arrangement. This prepayment would be recognised as an expense when the combined goods or services are provided under the SaaS arrangement.

5. Question 3: If the customisation is provided by a third party, is the third party a subcontractor of the SaaS provider?

The SaaS provider or another third party supplier might provide the CC services. The IFRS IC concluded that if a third party supplier performs the CC, those costs would typically be expensed as incurred. This is because when considering IFRS 15 to determine the nature and satisfaction of the services, it is likely the third party would be considered to have performed when the third party completes the tasks per the contract. However, the IFRS IC also discussed whether it would be appropriate to consider whether the third party is in substance a subcontractor of the SAAS provider and therefore the services should be considered as being provided by a single party for the purposes of assessment under IFRS 15.

6. When does the agenda decision apply?

The agenda decision has no formal effective date. The IFRS IC has noted that agenda decisions might often result in explanatory material that was not previously available, which might cause an entity to change an accounting policy. The IASB expects that an entity would be entitled to sufficient time to make that determination and to implement any change. Any change to the amounts recognised in the financial statements should be applied retrospectively, therefore comparative amounts might also need to be restated. Any material change in the financial statements as a result of entities reconsidering their accounting should be disclosed in a transparent way and comply with IAS 8.

Comparison to recent US GAAP guidance on customisation / configuration costs

On 29 August, 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 hosted by the vendor—that is, a service contract. Under the new US GAAP guidance, a customer will apply the same criteria for capitalising implementation costs of a Cloud Computing Arrangement as it would for an on-premises software license.

Capitalization requirements for Cloud Computing Arrangement implementation costs are aligned with ASC 350-40 internal-use software guidance.

The US GAAP guidance clarifies that implementation costs, including Cloud Computing Arrangements that do not transfer a software license, may qualify for capitalisation based on the phase and nature of the costs.

US GAAP also has specific guidance regarding the impairment of any cloud computing costs that have been capitalised. There are also multiple disclosures required under US GAAP that could differ from those required by IFRS.

Difference between IFRS and US GAAP

It should be noted that the requirements of IFRS and US GAAP differ for cloud computing arrangements. US GAAP favours an approach which more easily permits the capitalisation of configuration or customization costs relative to IFRS.

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