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Accounting for Cloud Computing Costs Under ASC 350-40

Considering cloud-based software or Software as a Service (SaaS)? If your company follows Generally Accepted Accounting Principles (GAAP) for financial reporting, you know that cloud software is priced like a service, and fees are expensed as they’re paid (OpEx).

 

A cloud solution may be treated as CapEx…

However, if your organization favors capitalizing software purchases, its worth knowing in 2016 the The Financial Accounting Standards Board (FASB)—the U.S. organization that sets GAAP standards—issued guideline ASC 350-40 to clarify how to treat cloud-based software as an intangible asset (CapEx), and when to consider it to be a service (OpEx). In some circumstances cloud software can be treated as a capital purchase. If your vendor offers the right to move their software in-house, accompanied by a license in your company’s name, you have the option of treating the acquisition as a capital purchase. If the answer is no to either point, you’re buying a service.

This distinction is becoming more and more important as enterprise software becomes increasingly cloud-based: 80% of software vendors are expected to adopt subscription as their primary licensing model by 2020.[i] This creates a challenge for companies that focus on CapEx, yet want to keep up with the move to the cloud.[ii]

 

Determine if your cloud software purchase includes a license

If you want to capitalize a cloud software purchase ask these two questions:

  1. Does your contract give you the right to take possession of the software license without paying a significant penalty?
  2. Can you operate the software in your own environment or at a third party site, outside of your software vendor’s environment?

If your cloud solution meets both criteria, then you can report the costs as CapEx. If your purchase doesn’t meet both criteria, then you report the fees as they’re incurred as OpEx.

 

Capitalize implementation costs too

Beware of trying to capitalize project costs if your SaaS purchase is treated as a service!  That same guideline ASC 350-40, specifically rules out treating related project costs as capital.  For example:

  • Project management costs, professional services acquired from a 3rd party
  • Migrating data from the old system to the new one. Upgrading legacy software to work with the new SaaS
  • Testing the new software
  • Revamping business processes
  • Training staff to use the new system
  • Related administrative and overhead costs
  • The more exact your budgeting, the more predictable your cash flow.   But, how can you reliably budget for the unexpected?  To minimize unplanned hits to your IT budget, are consumption-based software solutions the answer?

 

Boost your business case for cloud solutions

When you’re presenting your business case for an SaaS purchase, your CFO will be thinking about the bottom line. OpEx shows up above the EBITDA line and reduces reported earnings. But costs that can be converted to CapEx show up as an asset on the balance sheet, with amortization costs reported below the EBITDA line. This boosts earnings and frees up cash flow.

 

A better boost for your business case

Engage an expert. Central Technology Services is expert at helping enterprises and their vendors navigate the financial, operational and budgetary issues involved in purchasing enterprise software. We’re also expert at helping our customers interpret the complex FASB and IFRS guidelines which govern their software purchases. Central’s suite of customized software licensing solutions can help your company better manage your business, balance sheet and EBITDA drivers.

[1] Gartner, Market Trends: Prepare Now to Smooth the Inevitable Transition to a Subscription-Based Business Model, April 19, 2017,

[2] Forrester, Brief, Don’t Let CapEx Based Budgets Dampen Your Cloud Plans, October 2016.

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