Moving to the cloud?

Business
considerations for the new cloud
computing accounting standard
February 2019
 Moving to the cloud? Business
considerations for the new cloud
computing accounting standard
The benefits of cloud computing are considerable, and recent accounting
changes have made cloud solutions even more attractive to many Inside
businesses. On August 29, 2018, the FASB issued new guidance on a
customer's accounting for implementation, set-up, and other upfront costs ● Traditional IT vs.
incurred in a cloud computing arrangement (CCA) hosted by the vendor, that cloud computing
is, a service contract. Under the new guidance, a customer will apply the ● Accounting for
same criteria for capitalizing implementation costs of a CCA as it would for an cloud costs
on-premises software license. ● What can be
capitalized?
Moving data, applications, and platforms to the cloud may create substantial ● Agile software
business benefits because companies may be able to reduce capital expense development
outlays while maintaining a more flexible IT environment. However, ● CCA operational
companies should consider the financial reporting implications as well as details
broader tax and IT considerations as a result of the new accounting guidance. ● Optimizing for
other GAAP
changes
Cloud computing arrangements ● Tax impact

(CCAs), at a glance
Right to use software or hardware Types of arrangements

• Software as a service (SaaS) includes

a wide range of arrangements providing
Remote access: Computing resources reside web-based delivery of applications
on the vendor’s or a third party’s hardware managed by a third-party vendor.
• Platform as a service (PaaS) involves
Key accounting considerations a third party providing a framework for a
● Effective dates (ASU 2018–15): 2020 for team of software developers to create
public business entities, 2021 for all other and manage customized applications.
entities. • Infrastructure as a service (IaaS)
involves a third party providing
● Capitalization requirements for CCA on-demand, self-service access to
implementation costs aligned with ASC 350-40
highly scalable and automated
internal-use software guidance.
computing resources, including
● Capitalize implementation costs (coding, monitoring, networking, storage, and
testing, etc…) and amortize over the term other services.
of hosting arrangement.
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How traditional IT differs
from cloud computing

Traditional IT Cloud
Capital outlays for hardware Yes No
& applications
Flexible IT infrastructure No Yes
Built-in scalability No Yes
Customer’s costs categorization Capital–No impact to EBITDA[1] Operating–Reduces EBITDA

[1]
Earnings before interest, tax, depreciation, and
amortization

Changes to accounting for

cloud computing costs
Here’s a quick comparison of what has changed, comparing the previous standard to the new guidance:

Previous standard[2] New guidance

• Helped entities evaluate the accounting • Provides balance sheet, income
for fees paid by a customer in a CCA by statement, and cash flow classification of
distinguishing between arrangements the capitalized implementation costs and
that include a software license and related amortization expense.
arrangements that are solely a hosted • Aims to clarify the existing standard by
CCA service but did not address how to addressing the accounting for
account for implementation costs. implementation costs related to a
service contract.
• Requires additional quantitative and
qualitative disclosures.

[2]
Accounting Standards Update (ASU) 2015-05, Customer’s
Accounting for Fees Paid in a Cloud Computing Arrangement

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How the new accounting works

1
If the CCA includes a
2
If the CCA does not
3
The new guidance clarifies
software license, under the include a software that implementation costs,
old guidance, the license is license, the arrangement is including CCAs that do not
within the scope of the a service contract, and the transfer a software license,
internal-use software fees for the CCA are may qualify for capitalization
guidance. This addresses recorded in the same way based on the phase and
which costs should be as other SaaS expenses, nature of the costs.
capitalized, including the cost generally as operating
to acquire the license and the expense. The previous
related implementation costs. guidance does not
specifically address the
accounting for
implementation costs
related to a service contract.

CCA costs: What can be capitalized?

Potentially capitalizable Generally not capitalizable
External direct costs of materials Costs for data conversion activities
Third-party service fees to develop the software Costs for training activities
Cost to obtain software from third parties Software maintenance costs
Coding & testing fees directly related to software product

Also see PwC’s “In depth” guidance — Cloud computing arrangements: Customer accounting for implementation costs.

Capitalizing costs from CCA implementation:

Complexities from CCA operational Costs from other Tax impact

agile software details GAAP changes
development Page 7
Page 6 Page 7
Page 5

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Complexities from agile
software development

Key challenges in accounting for software

investments stem from the changes in software
development practices. Previously, a linear or
“waterfall” method typically involved a
sequential software design process that
“flowed” steadily downwards through lengthy
development phases. Accounting for
investments in linear/waterfall development
methods was relatively straightforward,
compared to today’s environment.

Current technology and software development

processes now largely follow an agile
development life cycle. With agile software
development, requirements and
solutions—including many involving CCA
arrangements—evolve through collaboration
among self-organizing, cross-functional teams.
These methods have many advantages.

However, reconciling agile development and

delivery models with outdated financial
reporting rules creates complexities:

● Compared to the older linear model, the

agile development process is more
iterative.
● The new accounting cost guidance is
brief and principle-based, providing few
prescriptive details.
● As such, sorting through the details of
development costs requires judgement
and often requires additional data
requirements, particularly for complex
operations in an agile environment.

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CCA operational details:
determining capitalization
Determining which operational aspects of CCA software implementation
activities are eligible for capitalization requires judgment and an analysis of
the nature of the costs incurred. As discussed earlier, this can be particularly
challenging in an agile environment. Addressing the operational challenges
that could influence which implementation activities are eligible for
capitalization may involve:

Process & control challenges Actions to consider

Determining which activities ● Assess the nature of the costs incurred (e.g., implementation costs versus training
qualify for capitalization versus costs or re-engineering costs).
expense treatment. ● Identify direct labor, incentive compensation, engineering costs, and meals &
entertainment costs.
● Segregate costs for a solution that has multiple components, such as on-premises
equipment, cloud solutions, hardware, software, third-party vendors.
Addressing operational ● Consider challenges for a sprint vs storyboarding approach and the respective
complexities that may arise from governance approach for each.
agile software development. ● Design a process to identify, evaluate and account for unsuccessful sprints.
Assessing the accounting for ● Determine the value of multiple instances of the same hosted CCA service used for
implementation costs for CCAs different business units or geographies (which could be in different stages
with multiple modules or of implementation).
components. ● Determine when amortization should begin for each module or component of the
hosted CCA service.
Evaluating CCA service provider ● Estimate and value the portion of the fee that relates to the implementation services to
arrangements to determine which apply the new guidance to these costs. The CCA service provider may not always
fees represent separate the fees for implementation services from the fees for the hosted CCA
implementation costs. service; instead, there may be a single monthly payment stream for all services.
Assessing cross-functional ● Account for data migration and integration into other systems.
arrangements. ● Develop approaches/methods for educating developers/engineers on accounting
considerations (i.e. framework).

To assist in addressing these challenges, companies can use this as an opportunity to leverage
technology through process automation. Visualization tools can be used to simplify and track the end
to end process of CCA for data already captured today, or tracked specifically for project purposes.
By leveraging existing technology and embracing process automation, business decisions can be
made quicker, with real-time information, leading to more efficient processes and comprehensive
outcomes related to accounting treatments and technology solutions.

Additionally, a cloud computing contract may require application of multiple accounting

standards—many of which have also recently changed. In these situations, companies need to
consider whether costs, which would otherwise have been within the scope of the updated cloud
computing standard, are accounted for using a different standard. For example, if a CCA includes an
explicit or embedded lease (e.g. dedicated equipment/servers), the company would need to
determine which costs are accounted for under ASC 842, versus the new cloud computing standard.

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Accounting for CCAs Tax impact of CCA
when optimizing for costs under the
other GAAP changes new standard
Many companies have also been The new cloud computing guidance creates
implementing the new revenue recognition an opportunity to enhance tax processes
and lease accounting standards. As part of and increase tax positions around these
this journey, many are exploring technology costs. As the nature of the CCA costs
solutions including CCA to automate and incurred will dictate treatment for both tax
optimize. A CCA can facilitate and book purposes, the new standard can
implementation of accounting changes and also be an opportunity to create synergies
create significant efficiencies. related to data gathering around such
positions. Key tax areas of analysis include:
It’s important to understand that the new
cloud computing standard could • Section 174: The ability to currently
significantly impact the recognition of costs deduct or amortize software development
for the implementation. Additionally, and research and experimentation
incorporating new automation systems
expenses (prior to tax year 2022) related
requires a front-loaded investment to select
new systems and get them up and running. to the implementation of systems,
solutions, applications, and middleware
To the extent that companies are related to cloud computing should be
implementing a CCA as part of other evaluated. From 2022 onward, all Section
accounting change initiatives, they should
174 expenses are capitalized irrespective
also ensure they have the right processes
of the nature of the costs incurred.
and governance to address the new
CCA standard.
• Section 41 Research & Development
Tax Credit: Software development efforts
related to cloud computing applications,
solutions, and middleware, as well as the
implementation of the cloud computing
standard into the customer’s financial
systems, should be analyzed for eligibility
for the Research & Development Tax
Credit, which could result in permanent
tax savings.

• Capitalization: As a result of tax reform,

if costs are capitalizable for tax purposes
and qualified for 100% bonus
depreciation, customers can immediately
expense these costs. If certain CCA costs
are associated with a lease, this would
also have tax implications.
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How PwC can help
PwC has deep expertise in implementing financial reporting changes. Our teams can assist with
financial reporting questions, as well as the broader business implications. The assistance we
can provide includes:

• Accounting analysis regarding capitalization and disclosures.

• Help with data, controls, and processes during both implementation and go-live.
• Analysis of the tax impacts of recent accounting changes and how to improve tax positions.
• Implementing cloud platforms & solutions and related performance management mechanisms.

Contact one of our professionals to have a deeper conversation about your organization’s
challenges with recent accounting changes and how we can be of assistance.

Contact us
Accounting Advisory Risk Assurance

Chris Smith Chris Wardak

Deals Partner, PwC US Principal, PwC US
Tel: +1 (408) 817 5050 Tel: +1 (646) 313 7790
Email: christopher.j.smith@pwc.com Email: chris.wardak@pwc.com

Brandon Campbell Jr. Ryan Hamill

Deals Director, PwC US Director, PwC Us
Tel: +1 (267) 330 1438 Tel: +1 (973) 236 5658
Email: brandon.a.campbell.jr@pwc.com Email: ryan.hamill@us.com

Tax Advisory

Edward Tarka Bob Woods

Partner, PwC US Partner, PwC US
Tel: +1 (267) 330 2370 Tel: +1 (206) 398 3341
Email: edward.a.tarka@pwc.com Email: robert.f.woods@pwc.com

Randy Friedman Kien Ha

Partner, PwC US Director, PwC US
Tel: +1 (267) 330 3458 Tel: +1 (206) 398 3297
Email: randel.friedman@pwc.com Email: kien.c.ha@pwc.com

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