Accounting Standards Update ( ASU ) 2015-05, Intangibles Goodwill and Other Internal-Use

Accounting Standards Update (“ASU”) 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement

What does this standard change? This guidance clarifies that customers should determine whether a cloud computing arrangement includes the license of software by applying the same guidance cloud service providers use to make this determination and eliminates the existing requirement for customers to account for software licenses they acquire by analogizing to the guidance on leases. Examples of cloud computing arrangements include software as a service, platform as a service, infrastructure as a service and other hosting arrangements. This amendment clarified that internal-use software guidance does not apply to hosted software unless both of the following criteria are met:

1. The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

Hosting arrangements that do not include software licenses should be accounted for as service contracts and not purchases of software licenses. The nature of any implementation and up-front costs a customer incurs when it enters into a cloud computing arrangement that does not transfer a software license should be evaluated, and the costs should be accounted for in accordance with applicable US GAAP (e.g., ASC 720-45, Business and Technology Reengineering, or ASC 720-15, Start-Up Costs). Generally, the related implementation costs are not capitalizable.

If a hosting arrangement includes a software license for internal use software, the software license should be accounted for by the customer under ASC 350-40. The asset for an acquired software license should be accounted for as an intangible asset – recognized and measured at cost, which includes the present value of the license obligation if the license is to be paid for over time. A license of software other than internal use software would be accounted for by the customer under other US GAAP (e.g., a research and development cost and software to be sold, leased or otherwise marketed). If a cloud computing arrangement transfers a software license, ASC 350-40 provides guidance on how to account for implementation costs such as training, data capture and conversion activities.

When is it effective? The guidance in this ASU applies to all companies and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The guidance can be applied either prospectively or retrospectively.

We expect this standard will apply to almost every entity since cloud computing has become so prevalent. Companies that incur implementation and up-front costs should evaluate their arrangement to determine if these costs are capitalizable.