How SaaS agreements affect financial reporting

Control as a precondition for recognition of an asset 

Software-as-a-service (SaaS) agreements generally allow the user to access an application over the contract term in exchange for a fee, but the user does not obtain a software licence or have a right to take possession of the software, which runs on a cloud infrastructure. IFRS do not contain explicit guidance on the user’s accounting for SaaS agreements. However, two questions have been discussed in the IFRS IC and IFRS preparers must therefore consider the agenda decisions when accounting for costs arising from these agreements. 

The IFRS IC believes that an agreement for a right to receive access to software is a service agreement in which the user receives the service over the term of the agreement. The user has no control over the underlying software, and therefore no asset can be capitalised (cf. Figure 1).

Table 1: Intangible asset versus service contract

The IFRS IC addressed the treatment of configuration and customisation costs in SaaS arrangements in March 2021. Two fundamental questions arise for accounting purposes:

• Do the costs result in an intangible asset?
• If not, should the costs be expensed as incurred or accrued as prepayments?

Costs for configuration and customisation

As a rule, in addition to SaaS fees the company also incurs additional and sometimes considerable costs for configuration and/or customisation to its own systems. The IFRS IC differentiates these costs as follows:

• Configuration: this includes setting various "flags" or "switches" within the software or defining parameters to set up the existing software. No additional software code is set up but the existing software code is set up to function in a particular way for the user’s benefit.
• Customisations: this involves changing the existing software code in the application and writing additional software code if necessary. This usually results in new or changed features.

Accounting

Figure 1 explains how the costs for configuration and customisation should be accounted for.

Figure 1: Questions on accounting for the costs of configuration and customisations

Question 1: Do the costs of configuration and customisation meet the definition of an intangible asset?

The IFRS IC states that users in SaaS arrangements generally would not recognise an intangible asset because they do not control the software being customised and the customisations do not create an asset that is separate from the software. However, only if the implementation results in an additional user-controlled code it should be assessed whether the recognition criteria of IAS 38 are met (IAS 38.25 and 38.75).

Question 2: Are the configuration and customisation services “distinct” from the SaaS agreement?

When the services are provided by the SaaS provider or its subcontractor, the question arises as to when the costs should be recognised. Costs that are distinct from the SaaS agreement shall be recognised over the period of the customisation service. If the service is not distinct from the SaaS agreement, the costs would be recognised as a prepayment and spread over the term of the SaaS agreement. The assessment of whether the configuration and customisation services are distinct from the SaaS agreement depends on the fact and circumstances of the agreement. If configuration and customisation services lead to a significant change in the use of software according to the agreement, it is to be assumed that these services would not be distinct (cf. by analogy with IFRS 15.29(b) in conjunction with IFRS 15.BC110).

Question 3: Is the third party carrying out the configuration and customisation a subcontractor of the SaaS provider?

The configuration and customisation services can be provided by the SaaS provider or by a third party. In the case of the latter, the costs are typically expensed as incurred. IFRS IC requires an assessment as to whether the third-party provider is a subcontractor (agent) of the SaaS provider; in this case, the configuration and customisation services are deemed to be provided by the SaaS provider (see question 2). This assessment involves the exercise of significant judgement. The following questions can be helpful, which, if answered with yes, indicate the third party is in substance a subcontractor:

• Can the SaaS provider in a way instruct how the work is performed?
• Was the SaaS provider involved in engaging the third-party provider?
• Do the terms of the SaaS provider depend on the fulfilment of the services by the third-party provider?
• Is the SaaS provider primarily responsible for the services provided by the third-party provider?

Implementation in practice

IFRS users should review and, if necessary, adjust the accounting of configuration and customisation costs incurred in previous reporting periods. This is particularly relevant if they have capitalised these costs. Any change to the amounts recognised in the financial statements should be applied retrospectively by adjusting the previous year's figures.

The monitoring of costs subject to capitalisation requires appropriate processes and tools. To make matters more complicated, companies often have complex IT infrastructures that require interfaces and adjustments during the implementation stage. In addition, the following aspects must be taken into account:

• The costs are often analysed and allocated retrospectively to the different elements of the project.
• Information on costs is not recorded in the necessary level of detail, which makes allocation difficult.
• The data and information are stored in different locations.
• As the IT infrastructure becomes more important, the documentation requirements become more extensive.
• The recording and allocation of costs are not comprehensively monitored.