From the IFRS Institute – June 4, 2021
Customers in software-as-a-service (SaaS) arrangements face complexity in determining the appropriate accounting under IFRS Standards for fees paid to the cloud service provider and related implementation costs. A recent agenda decision of the IFRS Interpretations Committee (IC) provides some clarity, and confirms differences with US GAAP. In this article we summarize financial reporting considerations and provide a framework for accounting for the related implementation costs.
What is a SaaS arrangement?
A SaaS arrangement, like those for platform-as-a-service (PaaS) and infrastructure-as-a-service (IaaS), is a cloud computing arrangement. A SaaS arrangement is also one type of software hosting arrangement. In a software hosting arrangement, a customer obtains access to software hosted by the software vendor (or a third party on its behalf). In some hosting arrangements, the customer’s right to access the hosted software gives rise to a software intangible asset (i.e. a license). In others, no software intangible asset is obtained; these arrangements are commonly referred to as SaaS arrangements.
Existing guidance under IFRS Standards does not explicitly address customers’ accounting for fees paid to SaaS providers or implementation costs incurred in SaaS arrangements. However, two IFRS IC agenda decisions provide a framework for the accounting.
- A 2019 agenda decision distinguishes hosting arrangements in which a customer receives a software intangible asset from those that do not, and therefore are service contracts (i.e. SaaS arrangements).1
- An April 2021 agenda decision includes guidance on customer accounting for implementation costs incurred in a SaaS arrangement.2
The accounting framework outlined in the remainder of this article is consistent with these agenda decisions.
Does the software hosting arrangement give rise to a software asset?
At the contract commencement date of a hosting arrangement, a question arises about whether a company receives a software asset, either under the guidance in IAS 383 or IFRS 164 (i.e. a software lease), or instead solely receives SaaS.
In our experience, software hosting arrangements usually do not give rise to a software asset. They generally do not meet the definition of a lease, and frequently do not give rise to an intangible asset under IAS 38.
The right to access the vendor’s software generally does not give rise to an intangible asset because that right does not in itself give the customer control over a software intangible asset that it can obtain the future economic benefits from and restrict others’ access to. However, in some circumstances a company may reach a different conclusion; features of a hosting arrangement that we believe may indicate the company obtains control of a software intangible asset include:
- the right to take possession of a copy of the software and run it on the company’s own or a third party’s computer infrastructure; or
- exclusive rights to use the software or ownership of the intellectual property for customized software – i.e. the software vendor cannot make the software available to other customers.
If a company determines that a hosting arrangement does not give rise to a software intangible asset, it recognizes the related expenditure as it receives the SaaS – i.e. over the SaaS period. If a company pays for the SaaS in advance, it recognizes a prepaid asset. Conversely, a company recognizes a financial liability if it receives access to the software in advance of paying for it.
Implementation costs: capitalize or expense?
In conjunction with a software hosting arrangement, a company may incur various upfront implementation costs. Common examples include testing, data conversion and migration, interfacing, configuration and customization costs. The accounting for implementation costs depends on whether the company receives a software intangible asset under IAS 38.
Arrangement gives rise to a software intangible asset
In a software hosting arrangement that gives rise to a software intangible asset, the cost of that software asset is determined based on the guidance in IAS 38. The cost of the asset includes the directly attributable costs of preparing the software for its intended use. Consistent with an on-premise software license, many implementation costs are therefore capitalized as part of the cost of the software asset – e.g. internal employee payroll and benefits costs, and external professional service fees incurred to install, configure and test the software.
Arrangement does not give rise to a software intangible asset
In a SaaS arrangement, upfront implementation costs are often required to be expensed when the related implementation services are performed. This is because the customer’s right to access the hosted software is not a software intangible asset for the customer. An exception arises when either:
- the implementation services are not distinct from the SaaS; or
- the cost gives rise to a separate tangible or intangible asset – e.g. the purchase of IT equipment or the development of a software interface the customer controls.
We believe the following framework should be applied to determine the appropriate accounting for implementation costs in a SaaS arrangement.
Are the implementation services performed by the SaaS provider?
In some SaaS arrangements, the SaaS provider may perform implementation services in addition to providing the SaaS. In that case, a customer should assess the implementation services and determine whether they are distinct from the SaaS. The performance obligation guidance in IFRS 155 provides a relevant framework to determine whether implementation services are distinct from the SaaS.
We believe services provided by the SaaS provider that could be performed internally or by a third party other than the SaaS provider are generally distinct from the SaaS. In that case, the SaaS provider’s implementation services are not integral to the customer’s ability to derive its intended benefit from the SaaS offering because substantially similar services can be obtained elsewhere. Contractual restrictions requiring the customer to obtain the services from the SaaS provider do not alter this assessment.
In our experience, most implementation services (e.g. configuration, installation, testing) usually could be performed by a third party that is not the SaaS provider.
If the implementation services are distinct from the SaaS, the related costs should be expensed as the services are provided unless they give rise to a separate intangible asset under IAS 38. In contrast, if the SaaS provider is the only company that can provide a particular implementation service and that service is integral to the customer’s ability to derive its intended benefit from the SaaS, this indicates that the implementation service is not distinct. In that case, the related implementation costs should be recognized as expense over the SaaS period – i.e. as part of the cost of that service. If the customer pays for the implementation services in advance (e.g. through an upfront fee), it should recognize a prepaid asset.
Does implementation expenditure give rise to a separate intangible asset?
Implementation costs related to a SaaS arrangement are often significant. However, in our experience, there are limited circumstances in which a separate intangible asset that can be recognized is acquired or created.
The directly attributable costs of preparing software for its intended use are capitalized only when a company acquires a software intangible asset. A SaaS arrangement does not itself include such an asset; therefore, the directly attributable costs incurred to prepare the SaaS for its intended use (e.g. configuration and testing) are not capitalized. Instead, these costs should be expensed when they are incurred (i.e. when the service is received) unless, as outlined above, the implementation service is not distinct from the SaaS.
The costs of data conversion and data migration generally do not create a separate intangible asset. This is because a company’s data – e.g. historical transactions recorded in a legacy software system or database – does not meet the recognition criteria under IAS 38. In addition, expenditure on training activities is required to be expensed as incurred under IAS 38.
However, we believe that an expenditure to create a new interface between a company’s existing software and the hosted software may result in the creation of a separate intangible asset under IAS 38 – e.g. writing new software code that the company controls.
Comparison to US GAAP
The FASB has issued explicit guidance on accounting for cloud computing arrangements, including SaaS arrangements.6 Under US GAAP, the subscription fees paid to the SaaS provider are generally recognized to expense over the SaaS period.
However, US GAAP requires implementation costs incurred by customers in SaaS arrangements to be capitalized and recognized over the ‘term of the hosting arrangement’, if those costs would be capitalized by the customer in a software licensing arrangement under the internal-use software guidance in ASC 350-40.7 That guidance applies to implementation costs whether the implementation services are provided internally, by the SaaS provider or by a third party.
Therefore, even though companies will generally reach consistent answers about whether a software hosting arrangement gives rise to a software intangible asset, differences exist from IFRS Standards on the treatment of implementation costs in SaaS arrangements. Companies will generally capitalize fewer SaaS implementation costs under IFRS Standards than under US GAAP.
See our article IFRS Perspectives: IFRS vs. US GAAP: R&D costs, for a discussion of IFRS capitalization criteria for intangible assets compared to US GAAP.
In our experience, the accounting for SaaS (and other cloud computing) arrangements is of increasing importance given their growing prevalence. Reaching appropriate conclusions about whether a software hosting arrangement gives rise to a software asset, whether implementation services are distinct from the SaaS, and whether an IAS 38 intangible asset is created by implementation activities can have significant effects on a company’s financial reporting. Customers entering into software hosting arrangements should ensure they have appropriate processes and controls in place to make these determinations; additionally, dual preparers should remain vigilant about significant GAAP differences in this area.
- Customer’s Right to Receive Access to the Supplier’s Software Hosted on the Cloud (IAS 38 Intangible Assets), March 2019
- Configuration or Customization Costs in a Cloud Computing Arrangement (IAS 38 Intangible Assets), April 2021
- IAS 38, Intangible Assets
- IFRS 16, Leases
- IFRS 15, Revenue from Contracts with Customers
- ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract
- ASC 350-40, Intangibles—Goodwill and Other—Internal-Use Software