Work from Home, Cloud-Based Computing Arrangements, & ASU 2018-15
The COVID-19 pandemic has prompted unprecedented disruptions across almost every facet of the professional world over the last six months. Many companies were faced with moving to a remote environment seemingly overnight, and those with a robust, cloud-backed infrastructure in place were able to transition much faster than those that were less equipped. As the U.S. enters the seventh month of the pandemic, silver linings of moving to a remote environment have emerged. Some employees enjoy the added flexibility—a May 2020 Robert Half survey indicated that 60 percent of office professionals who transitioned to remote said they had a better work-life balance without a commute.1 Employers also may begin to weigh potential cost benefits of reducing their physical presence even beyond the pandemic. Further, a study performed by the University of Chicago in June 2020 found that 37 percent of jobs in the U.S. can be performed entirely at home.2 All of these indicate the shift to remote work may be more permanent for certain positions within certain industries.
To accommodate the initial shift to a remote environment at the start of the pandemic, many employers were forced to quickly ramp up the tools for employees who suddenly found themselves working out of their homes. A CNBC survey of technology executives found that 68 percent believed their remote work resources were more robust than pre-pandemic levels.3 The increased investment in technology, especially cloud-based platforms that support collaboration in remote environments, is likely to continue.
Based on the new focus in this investment, it’s prudent to revisit the related accounting guidelines to help ensure expenditures are properly expensed or capitalized. Accounting guidance for costs related to software ultimately sold, leased, or marketed; accounting guidance for costs relating to software developed or obtained for internal use; and accounting guidance related to cloud-based service contracts are all different. Cloud-computing arrangements (CCA) used to enhance and further support a remote work environment will most likely fall under the internal-use guidelines (Accounting Standards Codification (ASC) 350-40, Intangibles—Goodwill and Other—Internal-Use Software), though it’s critical to first determine whether the CCA contains a license component or is strictly a service contract. Selecting incorrect guidance could ultimately lead to a financial misstatement due to the nuances within the different standards. To follow the licensing guidance, a customer must have both the contractual right to take possession of the software at any time without significant penalty and the ability to either run the software on its own hardware or contract with an unrelated vendor to do so (ASC 350-40-15-4A). Otherwise, the arrangement is presumed to be a service agreement.
Until recently, there was diversity in practice regarding implementation fees for CCAs determined to be a service contract. These fees can be substantial depending on such factors as level of customization and complexities within both the existing system and new software. Accounting Standards Update (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, provides clarification: certain implementation costs incurred during the application development stage must be capitalized. While each type of implementation fee requiring capitalization isn’t specifically outlined in the official guidance, the Emerging Issues Task Force discussed costs such as integration, customization, configuration, installation, design, coding, and testing in its July 2017 deliberations.4 It’s expected that companies will use the existing guidelines within ASC 350-40 to determine whether to capitalize or expense costs; for example, implementation costs associated with certain data conversion activities will likely need to be expensed.
One key feature of the new guidance relates to the amortization of the implementation fees for CCAs determined to be a service contract. The amortization expense is presented in the same income statement line item as the CCA expense; it’s not a component of amortization of intangible assets. This means the amortization of implementation fees wouldn’t be added back as a component of earnings before interest, taxes, depreciation, and amortization (EBITDA), as the amortization would likely be classified as an operating expense. This may be an important consideration for some companies, as the amortization of CCA implementation expenses may affect operating expenses (and, therefore, EBITDA) for the duration of the entire CCA term versus in only the year of cash outlay. Further, implementation fees associated with CCAs determined to have a license component, on the other hand, are amortized through amortization of intangible assets.
ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years for public business entities and for fiscal years beginning after December 15, 2020, for all other entities. Early adoption is permitted, with either retrospective or prospective transition methods allowed.
As investments in software used to support remote work increase, it’s necessary to revisit all applicable accounting guidance to help ensure appropriate standards are applied. The application of the incorrect standard could lead to a financial statement misstatement, which, depending on the nature of the investment, could be significant. For more information, reach out to your BKD Trusted Advisor™ or use the Contact Us form below.
1 http://rh-us.mediaroom.com/2020-05-01-Survey-Employees-Share-Views-On-Current-And-Post-Pandemic-Workplace ↩
2 https://brentneiman.com/research/DN.pdf ↩
3 https://www.cnbc.com/2020/06/24/new-tech-tools-employers-are-using-to-keep-watch-on-remote-workers.html ↩
4 https://www.fasb.org/cs/ContentServer?c=Document_C&cid=1176169364442&d=&pagename=FASB%2FDocument_C%2FDocumentPage ↩