By Jonathan Kraftchick
Currently, there is no guidance on how to account for fees paid in a cloud computing arrangement (ex. software as a service). As the contracts have become increasingly frequent, divergence in practice from cloud customers has grown, as have costs to determine how to account for these fees. Previous guidance was aimed only at the provider of the service or software. As a result, on April 30, 2015, FASB released ASU 2015-05 detailing how to determine whether a cloud computing arrangement includes a software license or a service contract.
Software Licenses v. Service Contracts
ASU 2015-05 does not change any accounting. The primary goal is to assist in determining whether an entity has a software license or a service contract. Let’s start with a definition of ‘the cloud’ or a ‘hosting arrangement’. Simply put, in these arrangements, the end user never takes possession of the software. The software lives on the vendor’s (or a 3rd party’s) hardware and the customer access the software on an as needed basis via the internet.
For a hosted arrangement to qualify as a software license, it must meet two criteria.
- The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
- It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.
There you have it. If both of the above criteria are not met, the arrangement is treated as a service contract and will likely expense the fees as the services are received. However, if the arrangement qualifies as a software license, the fees will be accounted for by the customer similarly to other internal-use software (likely capitalized over the life of the license).
When do I have to do anything?
For public entities, ASU 2015-05 will be effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. For all other entities, the amendments will be effective for annual periods beginning after December 15, 2015, and interim periods in annual periods beginning after December 15, 2016. Early adoption is permitted.