Accounting for Internal-Use software and Cloud Computing Arrangements

Software is an every day use for businesses. Some software is cloud-based which is accessed through the internet and other is housed internally on the company’s server. Over the past few years, there has been a shift from computer software housed internally to more cloud computing arrangements with a service agreement. When it comes to recording the costs for software, the type of software (and the signed contract) matters.

Once cloud-based software is acquired – and you have no plans to market it externally – ask these questions:

1. Does the contract say you make take possession of the software?
2. Are you capable of running the software on your own hardware?
3. Can you contract another company to run the software?

If you answer yes to all the questions above, then you have a purchase of internal-use software.

Accounting for internal use software requires considering three major components under FASB ASC 350-40.

• Preliminary project costs – These costs include evaluating software choices, vetting companies, and determining technology needs. These costs should be expensed as incurred.
• Application development stage costs – These costs include the core software package, coding, installation, testing, customization, data integration, and hardware costs. These costs should be capitalized.
• Post-implementation costs – These costs include training and maintenance which should be expensed as incurred.

If you answer no to all the questions above, then you do not have a purchase of software but rather a cloud computing arrangement that is a service contract that should be expensed over the life of the contract. The service contract allows you to access and use the infrastructure of the software which is hosted by the vendor or their assignee.

An example of this would-be QuickBooks Online or an Antivirus software where you are billed monthly for the service and you recognize an expense each month. If you were to quit paying for the services, your access would be shut off.

Developments in accounting standards. Why accounting is different between software types.

Often times large ERP (enterprise resource planning) systems have elements of high customization that come at a substantial price. In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to address the accounting for fees paid in a Cloud computing arrangement that is a service contract. Prior to the issuance of this ASU there was a lack of specific guidance related to accounting for these costs in accordance with generally accepted accounting principles.

This ASU requires the customers of a cloud computing services contract to analyze implementation costs for capitalization, similar to the application development stage costs noted above. These costs should be capitalized and expensed over the term of the hosting agreement and should be evaluated for impairment. This ASU is effective for non-public companies with annual periods beginning after December 15, 2020 (i.e. the effective date for calendar year companies is January 1, 2021).

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