Not familiar with Accounting for Software Leases under IFRS (International Financial Reporting Standard) 16 or Accounting for Subscription Software under FASB (Financial Accounting Standards Board) ACS 350-40? Don’t worry, you’re not alone. But, if your organization is purchasing perpetual license, subscription or cloud software, these seemingly arcane bodies may have plenty of influence on your decision. Here’s a primer with some important facts to consider.
Who are IFRS and FASB anyway?
Briefly, the IFRS Foundation is a not-for-profit, organization established to develop a single set of high-quality, understandable, enforceable and globally accepted accounting standards—IFRS Standards—and to promote and facilitate their adoption. They’re important because capital markets need high quality, financial information delivered in a common, consistent format. IFRS Standards are currently required in over 125 jurisdictions around the world, excluding the USA.
Their US equivalent, the Financial Accounting Standards Board (FASB) is an independent, private-sector, not-for-profit organization that establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow Generally Accepted Accounting Principles (GAAP).
Why are IFRS and FASB relevant to enterprise software?
Companies have long followed their rules regarding how they must treat the purchase of licensed software, maintenance, consulting and project expenses. Two paths - CapEx or OpEx. In separate publications FASB and IFRS issued new guidelines on how companies headquartered in the USA account for the purchase of subscription/SaaS software and services as well as revised treatment of operating and capital leases for non-US companies.
Accounting for Software Leases Under IFRS 16
IFRS 16 is a new international accounting standard applicable to global, non-US companies that will become effective on the 1st of January 2019. Under IFRS 16, the majority of leases will be capitalized and reported as an asset with an offsetting lease liability on the balance sheet, eliminating the reporting of off-balance sheet leases that appeared as operating expenses on the income statement.
These changes may have a significant potential impact on the financial results and reporting of your organization. For more information on the IFRS 16 read our report here.
Accounting for Subscription Software Under FASB ACS 350-40
The FASB introduced a new guideline to ASC 350-40 in December 2015. ASC 350-40 redefined the rules on how companies account for the professional services, development, project management, labor and implementation costs associated with cloud and SaaS purchases. What was a capital expense is now operating. Is this a problem for some companies? You bet. After decades of capitalizing project costs to minimize bottom line impact, large software projects now hit the EBITDA line. Major software companies and service providers including Salesforce and Google have weighed in, saying this guideline will slow the adoption of SaaS offerings.
Operational benefits aside many companies are now reconsidering SaaS in favor of traditional on-site software. For the latest update on the FASB ACS 350-49, click here.
Points to Consider
- Software is sold in different licensing models – perpetual, subscription and cloud – which impact your budgets and balance sheets differently. Here are some pros and cons:
- Subscription and cloud licenses are treated as OpEx and impact your income statement immediately increasing operating costs and reducing earnings.
- Maintenance costs were and remain an operating expense.
- Some industries like oil, gas and utilities favor CapEx and switching to OpEx will prove difficult or impossible.1
- As a business unit lead or the CIO, establishing your project benefits remains important but you need IT or corporate finance at the table.
- Here’s the challenge. While traditional, perpetual licenses have traditionally been the largest category spend, 70% of CIOs surveyed by the research firm Morgan Stanley expect SaaS spend to increase in 2017, up from 57% last year.2 We’re in a period of unprecedented change in the delivery of enterprise software and the range of options available to the corporate buyer. In another study, 83% of respondents said that flexible software licensing and accessibility across multiple devices are extremely important to them.3 Changes in FASB and IFRS guidelines are still being digested and have created confusion in both vendor and end-user organizations.
- Current FASB guidelines on the upfront costs of cloud acquisitions means your company can no longer depreciate many of the fees involved in cloud migration. Read more about this here.
- New IFRS guidelines revise the accounting practices for all capital and operating leases effective 2019. Read more about this here.
Confused? You could wade through this minefield of rules and guidelines on your own, or you could call the software industry’s leading financial services partner, Central Technology Services. At Central we specialize in assisting Fortune 1000 companies and their vendors manage the financial, operational and budgetary issues associated with acquiring enterprise software and related technology assets.
- Brief: Don’t Let Capex Based Budgets Dampen Your Cloud Plans. October 2016.
- Morgan Stanley Research. IT Budget Growth Poised for Acceleration in 2017, June 2017.
- Software Vendors are losing revenue due to rigid licensing and delivery options. November 2015.