From the IFRS Institute – May 31, 2019
Customers face two accounting issues in relation to software as a service (SaaS) arrangements which IFRS, unlike US GAAP, does not explicitly address – the accounting for (1) fees paid to the SaaS provider and (2) related implementation costs. The IFRS Interpretations Committee recently provided clarification on some aspects of the first issue, but not the second. Meanwhile, the FASB issued US GAAP guidance with no IFRS equivalent that requires capitalizing certain implementation costs and specifies their presentation. As dual reporters begin to adopt the new US GAAP guidance, it may be a good time to consider how SaaS arrangements are accounted for under IFRS.
A SaaS arrangement is a type of cloud computing arrangement in which the supplier (the cloud service provider) provides the customer access to application software residing on the supplier’s or a third-party’s cloud infrastructure. The infrastructure comprises a collection of hardware and software, including network, servers, operating systems and storage. SaaS arrangements are prevalent across all sectors and are expected to continue to grow.1
The customer generally cannot take possession of the software. Instead, the customer accesses and uses the software on an as-needed basis over the internet or via a dedicated line. SaaS arrangements typically have an initial non-cancellable period with options for the customer to extend the term. The associated fees, which are generally paid periodically throughout the contract term, may be variable (e.g. usage-based) and the rates could change from period to period or could include tiered pricing based on volume.
It is also common for the customer to incur implementation costs at the inception of SaaS arrangements. Depending on a number of factors, including the amount of data to be migrated and complexity of a company’s existing applications and data, these implementation costs may be significant. While neither US GAAP nor IFRS contain a definition of implementation costs, usually those include costs to customize or configure the software, develop and implement interfaces between the company’s existing systems and the SaaS solution and convert or migrate existing data for use by the SaaS solution. These costs may be paid by the customer to the SaaS provider (either together with ongoing hosting fees or separately), paid to an unrelated third party (e.g. consultant) or incurred internally.
IFRS does not have specific guidance on SaaS arrangements, and therefore it is often difficult to assess whether the customer should recognize the right to use the software as an intangible asset or should account for the arrangement as a service contract.
This determination affects the timing of recognition of the costs, along with metrics such as capex spending or EBITDA. It requires judgment considering the terms and conditions of the agreement.
The IFRS Interpretations Committee recently issued an Agenda Decision clarifying that if the customer receives a software asset at the commencement of a SaaS arrangement, either in the form of an intangible asset or a software lease, the customer recognizes an asset at the date it obtains control of the software. Otherwise, the arrangement is a service contract. Consequently, the key determination is whether the customer receives a software asset at contract commencement.
Comparison to US GAAP
US GAAP2 has explicit criteria for determining whether or not to recognize an asset for SaaS arrangements. The customer recognizes an intangible asset, assuming criteria for capitalization of internal-use software are met, if the customer has both:
If either criterion is not met, the arrangement is accounted for as a service contract.
A customer receives a software asset if the customer obtains control of software at the contract commencement date or the contract contains a software lease. Therefore, to make this determination, the customer evaluates the terms and conditions of the arrangement considering the control concept in the intangible assets and leases guidance.
Under IAS 38,3 an entity controls an intangible asset if the entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits. IFRS 164 states that the customer has the right to control the use of an asset when the customer has both the right to:
Features of SaaS arrangements that may affect the assessment of whether the customer receives a software asset at contract commencement include the following.
An arrangement that grants the customer exclusive use of software for the contract term conveys to the customer the right to obtain substantially all the economic benefits from use of the software.
However, in order to conclude that the customer receives a software asset at contract commencement, the customer must also assess whether it has the right to direct the use of the asset throughout the contract term. A customer generally meets this test if the supplier has given up the decision-making rights to change how and for what purpose the asset is used throughout the period of use (e.g. deciding how and when to update or reconfigure the software) and transferred them to the customer at contract commencement.
Rights to download software (or a copy) may be an indication that the customer controls a software asset at the contract commencement.
However, the customer needs to assess the other terms and conditions of the arrangement to determine its rights over the software. Examples include which party determines the nature and timing of any modifications or updates to be made to the software over the contract term, and whether the software must be hosted on the supplier’s hardware for the contract term.
When the customer has the right to take possession of the software and use it on the customer’s (or a third party’s) hardware, the customer has the right to obtain substantially all the economic benefits from the use of the software and to direct the use of the software throughout the contract term. Therefore, the customer likely has a software lease and would recognize an intangible asset at contract commencement.
These rights are similar to the criteria provided in US GAAP described above, and therefore a similar conclusion might be reached under both US GAAP and IFRS.
Under IFRS, accounting for implementation costs for the SaaS arrangement depends on whether the customer receives a software asset at contract commencement; and the conclusions may not align with US GAAP.
Comparison to US GAAP
US GAAP6 was recently amended to require implementation costs incurred by customers in a service arrangement to be deferred and recognized over the term of the arrangement if those costs would be capitalized under the internal-use software guidance in ASC 350-40.7 The change is expected to reduce diversity in practice and lead to more implementation costs being deferred. In essence, the timing of expensing implementation costs should now align, whether the arrangement is accounted for as a service contract or as the transfer of a software license. Only the presentation may be different – i.e. deferred implementation costs presented as other assets if a service contract or as an intangible asset if a software license. A company also presents amortization of the implementation costs in the same line item in the income statement as the expense for fees for the associated arrangement.
As companies adopt the new US GAAP guidance on implementation costs, we expect this difference, and accounting for cloud computing arrangements in general, to be of increasing importance for dual reporters. Reaching a capitalization conclusion typically requires judgment and may have far-reaching consequences on business ratios. Practical consequences should not be underestimated either because deferral of costs requires robust cost tracking mechanisms and controls.
See IFRS vs. US GAAP: R&D costs, for a general understanding of IFRS capitalization criteria for intangible assets, compared to US GAAP.
Understand the role of IFRS Interpretations Committee Agenda Decisions and how to apply them.
IFRS has specific requirements for government grants that apply to all entities; US GAAP has limited guidance for ‘business entities’.