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Capitalize or Expense SaaS implementation costs?

Liz Armstrong's Profile

Capitalize or Expense SaaS Implementation Costs

My client is implementing a cloud based (SaaS ) financial system and wants to capitalize the implementation costs under the computer software developed or obtained for internal use rules (ASC 350-40).  Since the costs to design and install the underlying asset (e.g. software) doesn't reside on the balance sheet under the SaaS model, I believe they need to expense these costs. Under the SaaS model, the company is renting a service vs. software licensing is purchasing an asset. So if the client was implementing a traditional ERP solution (e.g. Oracle, Great Plains) they could capitalize the implementation costs but if they implement a SaaS solutions (e.g. Netsuite) they would need to expense.  Would appreciate feedback from anyone who has experience with this issue or if their auditors have provide guidance on treatment.

 

Answers

Stephen Turk
Title: Principal
Company: Stephen Turk, CPA
(Principal, Stephen Turk, CPA) |

Liz:
Under a traditional ERP model, with licensed software, a company can only capitalize certain implementation costs - basically, those associated with application development. A lot of the implementation costs will fall into other categories, including scoping, design, evaluation and redesign of business processes, training, etc. that do not qualify for capitalization.
The capitalizable costs might include building the chart of accounts, designing and testing reports, etc. These activities would be essentially the same regardless of whether a particular software is being used under a license model or a SaaS model, and the capitalization criteria would be the same.
That is, the focus should be on whether the implementation activities are application development related. This does not depend on whether the underlying software package is licensed or SaaS, or whether or not it's on the balance sheet.

Sarah Jackson
Title: Associate Editor
Company: Proformative
(Associate Editor, Proformative) |

Hi Liz,

Proformative offers 400+ business courses with free CPE, many on Accounting.

Lloyd Davies
Title: Senior Director, Finance
Company: Jazz Pharmaceuticals
(Senior Director, Finance, Jazz Pharmaceuticals) |

I think I'd agree with Stephen on the kinds of costs that could be capitalized. The costs would be a long lived asset included in "Other noncurrent assets" rather than PP&E I think. The thing I was wondering about was the period over which you would amortize/depreciate the costs you did capitalize. With a SAAS model your asset is a right to use the software and if you are only committed to a one year contract would you depreciate over one year even though you have a reasonable expectation that you would be using the service for 3 years or longer. Sorry to answer a question with a question ;)

Len Green
Title: Performance Improvement Consultant and E..
Company: Haygarth Consulting LLC
LinkedIn Profile
(Performance Improvement Consultant and ERP Strategist, Haygarth Consulting LLC) |

Lloyd- I think your question about what period applies to the amortization is the one to answer. I know of companies that pay monthly for their Saas CRM system, while their SaaS accounting system may be paid quarterly or even annually in advance. If you have no/limited rights of refund to subscription fees paid in advance, what amortization period do you select?

Won't this become more important the more people choose cloud apps?

Manuel Soberanes
Title: Senior Revenue Accountant
Company: Soberanes Consulting
LinkedIn Profile
(Senior Revenue Accountant, Soberanes Consulting) |

Hi Everyone

Liz did you ever resolve this issue? My company is also wrestling with this and we cannot find any literature in the codification to support capitalizing implementation and setup costs associated with a SAAS product. These fees seem to be significant compared to the overall cost of the subscription but have no stand alone value without the ability to use the service. It seems that on the revenue side the seller would be allowed to defer the costs associated with implementation and setup services and once complete recognize the related revenue and costs over the service period. But in the case of the buyer of the service they would have to expense all of the implementation and setup fees when performed defeating the cost/benefit of SAAS in my opinion, since in essence the buyer still has a large up front cost and then a continuous lower cost over the subscription period (similarly to purchasing a perpetual license with associated pcs) Is there any other GAAP guidance other than ASC 350-40 internal use software that we can analogize too? Also under ASC 350-40-25-16 it states that "Entities often license internal use software from a third-parties. Though subtopic 840-10 excludes licensing agreements from its scope entities shall analogize to the Subtopic when determining the asset acquired in a software licensing agreement". My question on if this is since its not technically a license agreement since SAAS is classified as a service then shouldn't we use the 840-10 i.e. lease guidance and determine if this a capital lease or an operating lease? Any thoughts or input would be appreciated.

Ben Cohen
Title: COO
Company: QLM
(COO, QLM) |

Hi Manuel,

I'm dealing with the exact problem (capitalizing cloud services). Did you get any creative ideas to solve this issue?

Best,
Ben

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

I agree with Stephen's analysis. If you are modifying (adding programming) to the system, it's a capital expense since you indeed own that modification.

As far as Manuel's question, for many accounting systems, the license agreement is only valid as long as you pay an annual fee, thus if you stop paying your license expires and so you no longer have access to your data.

If that is the case, IMHO, you have an operating lease and expense it as such.

Anonymous
(Manufacturing Controller) |

Software acquisition and development costs for data conversion seem to be capitalized costs per ASC 350-40. How about internal or external costs to accumulate and organize the data so it can be converted and uploaded to the Cloud providor?

Anonymous
(VP - Fin) |

Data migration does not fall within the definition of Capitalizable Costs and is to be expensed.

Kevin Roones
Title: Senior Accounting Professional
Company: In-between
(Senior Accounting Professional, In-between) |

As is the case with a lot of accounting treatment issues, the key is the wording of the contract with the service provider. Is it clear what period the benefit is received for re the service fee (subscription fee)? The service fee should be expensed over the period in which the company receives the benefit.
For the software itself, does the contract specify who owns it? If the customer owns it, an asset should be recorded and expensed over the expected useful life.

The key is who has the rights to the software per the contract. See page 11 of the KPMG document linked below.

http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/building-successful-cloud-provider-service.pdf

Hope this helps.

Anonymous
(VP Controller) |

Thanks for attaching the KPMG document. It was extremely helpful. We are doing more and more SaaS and less software purchases and most people do not understand why we have to expense the implementation costs.

Keith Marquard
Title: Supervisor of Accounting
Company: Concordia Plan Services
(Supervisor of Accounting , Concordia Plan Services ) |

One thing I don't see addressed very well here is the lease-like nature of a systems hosting contract. The situation we have is as follows:
- A 3-year hosting and maintenance contract with with the company that makes the ERP software we've had in use for the last ten years. We do pay monthly but we're on the hook for the full three years of charges. We keep our existing site-licenses for their software and can go elsewhere at the end of the 3 years without having to repurchase the site-licenses. No software capitalization question for us at all.
- Upfront charges from the software vendor relating to data migration, implementing a software upgrade, and carrying over software mods from the previous version that just about equal 8 months of hosting and maintenance charges.
- A second outside vendor charging us for their services in assisting us in this transition (basically project management services). The charges just about equal three months of hosting and maintenance.

My thinking is that the service contract we've signed resembles a lease more than anything. Lease accounting (at least for now) is pretty clear that a lessee who receives an up-front payment from a lessor must then amortize that reduction in expense over the life of the lease. It's only logical that you'd also do the same with an up-front payment by a lessee to a lessor, especially if that payment is a significant percentage of the total future lease payments due under the contract.

Since:
1. The upfront payments we're going to incur are directly related to this migration and would not have been incurred without it, and
2 The migration could not have happened without either vendor.
The up-front costs should be amortized over the period of the service contract just like leasehold improvements would be for a real estate lease, or just like an up-front payment from lessor to lessee would be for any other lease.

FYI, our business reason for doing this change in systems hosting vendors is that the new vendor will be much cheaper than our existing one. Also, since this is their software, we are thinking they'll be better able to manage it.

There is no question of whether there are any fixed assets for us to capitalize. There aren't. But there are these up-front costs that will provide benefits to us over the period of the lease. Amortization seems only logical in order to match the expenses with the benefits derived from out new arrangement and also provide a better picture of the true cost of our systems operations over the term of the service agreement.

Dan Moldover
Title: Royalty
Company: Deltek
(Royalty , Deltek) |

Consider that this is a service agreement is not a lease. It is more akin to a magazine subscription or membership than a lease because no asset changes hands. The provider is allowing you to access their systems to process information. The data is under their control, not yours. Because your usage is under their control, you have to consider what guarantees, if any, there are that the provider will continue to operate. Does the provider have a specific obligation to provide the service in accordance with your specifications over a long term? It's not just a question of the legal right to use software during a contract dispute, which you might have with subscription software. Certainly, it goes beyond no longer having maintenance or support as you would with a perpetual license. Often in SaaS agreements, the provider has the option to modify the software at any time in a manner of their choosing. This may result in changes which diminish your usage of the product or make it completely unacceptable. Similarly, those changes may require any custom interfaces to be modified or re-built.

While there's a business expectation that you will utilize it over the minimum contract period, you have to consider what your rights are to the implementation (configuration and interfaces) under different circumstances. Only after examining those rights can you determine if you have a long term asset or not.

As to conversion & data migration costs, those are specifically excluded in guidance (350-40), even if they occur in the application development stage (which would analogous to the configuration stage of an implementation). Costs to build interfaces for conversion are capitalizable, but the conversion costs themselves would not be. I would consider analyzing, normalizing, and testing the results to be conversion costs and not costs of the interface. A more aggressive approach would be to consider some or all of those costs to be part of testing the interface. However, if the interface was not created by you or at your request, then those costs could not be included as the testing was completed prior to your project.

Earl Butler
Title: IT Finance Manager
Company: Fireman's Fund Insurance/Allianz
LinkedIn Profile
(IT Finance Manager , Fireman's Fund Insurance/Allianz) |

The move to the cloud or X-as-a-service (Xaas) is going to create a shift from capex to Opex. If you are using a Saas vendor like Salesforce.com you are do not own any Intellectual property and as you are only renting space in their solution. Other than custom interfaces, permanent integrations points, or permanent data conversion linkages. The transaction would be Opex. I be the first to tell you the accounting position on software capitalization is dated at best. Your best bet would be to talk with you chief accounting officer. The capex is in the asset ownership which is the could lies with the service providers.

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