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1.5 Cloud computing arrangements—scope
Publication date: 31 Dec 2021
us Software costs
As companies move their data, applications, and platforms to the cloud, software that a customer would have traditionally installed locally on its own servers is now often hosted on the vendor’s (or a third-party cloud platform provider’s) servers and accessed by the customer remotely. These arrangements are sometimes referred to as hosting arrangements or cloud computing arrangements (CCAs). Examples of CCAs include SaaS and other “as a service” arrangements, including platform as a service and infrastructure as a service. Some CCAs transfer a license to the software in addition to the service of hosting the software. It is important to determine whether, for accounting purposes, the CCA includes a software license in addition to the service or if it is only a service. ASC 350-40-15-4A contains the guidance for making this assessment for both vendors and customers in a CCA.
The guidance in the General Subsections of this Subtopic applies only to internal-use software that a customer obtains access to in a hosting arrangement if both of the following criteria are met:
- The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
- 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.
The right to take possession of the software at any time during the hosting period can be explicit, or implicit if the vendor creates a valid expectation that it will provide the customer with the right.
Determining whether the customer has the right to take possession of the software without significant penalty can require judgment. The phrase “without significant penalty” refers to the ability to (1) take delivery of the software without incurring significant cost and (2) use the software separately without a significant diminution in utility or value. Significant costs could include penalties that the customer would incur for terminating the hosting arrangement (including forfeiting a nonrefundable upfront payment for services), as well as costs the customer would incur for the necessary infrastructure to host the software itself. “Significant diminution in utility or value” generally refers to a reduction in features, functions, processing speed, or computing power of the software, including losing the right to receive upgrades or updates that are integral to the functionality of the software.
If both of the criteria in ASC 350-40-15-4A are met, the CCA includes a software license to be accounted for in addition to a hosting service. A CCA that does not meet those criteria should be accounted for solely as a service contract, regardless of whether the contract includes language that refers to a software license.
1.5.1 Cloud computing arrangements—customer’s accounting
A reporting entity that is the customer (i.e., a purchaser) of a CCA provided by a third-party vendor may be entering into an arrangement that is solely a service or acquiring a software license in addition to a service.
- CCA is solely a service: Although the reporting entity is not acquiring software in this situation, the determination of whether to capitalize the related implementation costs is based on the internal-use software guidance, as discussed in SW 4. The ongoing cost for CCA services is expensed as the service is received similar to other service contracts.
- CCA includes a software license: The costs to acquire the software license could be in the scope of the internal-use software or externally marketed software guidance, depending on the reporting entity’s use of the software. Refer to SW 1.3 and SW 1.4 for scoping considerations for software costs.
It is common for arrangements with third-party vendors to include multiple elements, such as a software license, SaaS, and other services. Refer to SW 3.6 for guidance on allocating costs related to a multiple-element contract with a third-party vendor.
Figure SW 1-2 details the relevant considerations for determining the appropriate guidance for costs incurred by a reporting entity that is the customer for a CCA.
Figure SW 1-2
Determining the relevant guidance for costs incurred by a reporting entity that is the customer in a CCA
Determining the relevant guidance for costs incurred by a reporting entity that is the customer in a CCA
1.5.2 Cloud computing arrangements—vendor’s accounting
A vendor providing a CCA to customers will need to assess whether the arrangement includes a license (i.e., whether the software is transferred to the customer) to determine which guidance to apply to the related software development costs. The guidance in ASC 350-40-15-4A (see SW 1.5) is used to make this assessment for both vendors and customers in a CCA.
- CCA is solely a service: As the software is solely used by the vendor to provide a service to customers, the related software development costs should be accounted for under the internal-use software guidance (see SW 3).
- CCA includes a software license: The software development costs incurred by the vendor for software being licensed to customers should be accounted for under the externally marketed software guidance (see SW 2).
Refer to Figure SW 1-1 for a decision tree for determining the relevant guidance for costs incurred by vendors to obtain or develop software, including software a customer accesses through a hosting arrangement.
Question SW 1-2
Which guidance applies to software development costs related to software that a reporting entity uses to provide a service to some customers in a hosting arrangement, but licenses it to other customers (as on-premises software)?
Which guidance applies to software development costs related to software that a reporting entity uses to provide a service to some customers in a hosting arrangement, but licenses it to other customers (as on-premises software)?
PwC response
Generally, if a reporting entity has substantive sales of on-premises software, the guidance for externally marketed software in ASC 985-20 should be applied to the related software development costs. This is the case even if the reporting entity is also using the same software to provide a service to customers in a hosting arrangement. If the reporting entity incurs costs that relate solely to the platform used for hosting the software or only the hosted version of the software (and not the licensed on-premises software), the guidance for internal-use software in ASC 350-40 may apply to those costs. Assessing which costs, if any, are subject to the internal-use software guidance in this situation may require judgment.
Question SW 1-3
What are the accounting implications if a reporting entity has capitalized costs under ASC 350-40 related to software it uses to provide a service (as a SaaS arrangement), but subsequently agrees to license the same software to a customer that wants to host the software itself?
What are the accounting implications if a reporting entity has capitalized costs under ASC 350-40 related to software it uses to provide a service (as a SaaS arrangement), but subsequently agrees to license the same software to a customer that wants to host the software itself?
PwC response
If an entity decides to sell software that was capitalized under ASC 350-40 based on an assumption that the software would be used only for internal use, the proceeds from the sale are applied against the carrying amount of that software in accordance with the guidance in ASC 350-40-35-7. Refer to SW 3.9 for further discussion of the accounting implications in these circumstances. The reporting entity should also consider whether future development costs (e.g., product enhancements or new software products) should be accounted for under ASC 985-20. As discussed in SW 1.4, ASC 350‑40‑15‑2C indicates that a pattern of selling software to a third party that was originally developed to use internally creates a rebuttable presumption that any software developed by that reporting entity is intended for sale, lease, or other external marketing.
Question SW 1-4
What are the accounting implications if a reporting entity has capitalized costs under ASC 985-20 related to software that it both (a) licenses to customers (as on-premises software) and (b) uses to provide a service (a SaaS arrangement), but subsequently discontinues licensing the software to customers?
What are the accounting implications if a reporting entity has capitalized costs under ASC 985-20 related to software that it both (a) licenses to customers (as on-premises software) and (b) uses to provide a service (a SaaS arrangement), but subsequently discontinues licensing the software to customers?
PwC response
Many reporting entities are transitioning from licensing on-premises software to providing SaaS offerings to customers. The accounting guidance does not specifically address the transition from externally marketed software to internal-use software. However, a reporting entity may conclude that it no longer intends to market software externally even though it has a history of licensing software to customers. As a result, development costs for new software products or enhancements to existing products (unless licensed for on-premises use by customers) may be in the scope of ASC 350-40. This determination could require significant judgment. If the reporting entity is transitioning to SaaS offerings, but expects to continue to have substantive licenses of on-premises software, ASC 985-20 should continue to be applied.
Question SW 1-5
Which guidance applies to development costs related to software that will be hosted by a third-party service provider (i.e., a party other than the reporting entity or customer) in arrangements with customers?
Which guidance applies to development costs related to software that will be hosted by a third-party service provider (i.e., a party other than the reporting entity or customer) in arrangements with customers?
PwC response
It depends on whether the third party is hosting the software on behalf of the reporting entity (the vendor) or the customer. If the reporting entity contracts with a third party to host software developed by the reporting entity (to be accessed by customers), the accounting for the related software development costs is no different than the reporting entity hosting the software on its own servers. The reporting entity should apply the guidance in ASC 350-40-15-4A (see SW 1.5) to assess whether the arrangement with the customer includes a license, which will determine which software cost guidance applies (see Figure SW 1-1).
If the customer purchasing the software chooses to utilize a third-party hosting service instead of hosting the software on its own servers, the reporting entity could conclude it has transferred the software to the customer. Thus, the related development costs would be accounted for under ASC 985-20.
Question SW 1-6
Which guidance applies to costs incurred by a reporting entity (a vendor) to implement a software product or a CCA for a specific customer?
Which guidance applies to costs incurred by a reporting entity (a vendor) to implement a software product or a CCA for a specific customer?
PwC response
Costs incurred to implement a software product or CCA for a specific customer are generally costs to fulfill a revenue contract and would be subject to the guidance in ASC 340-40, Other Assets and Deferred Costs—Contracts with Customers. In contrast, if the reporting entity incurs costs to make modifications to the software that benefit multiple customers, the reporting entity should consider the guidance in internal-use software or externally marketed software, as applicable.
1.5.2.1 Hybrid cloud arrangements
An arrangement that includes both a license to on-premises software and cloud-based services (such as SaaS) is sometimes referred to as a “hybrid” or “hybrid cloud” arrangement. While the term “hybrid cloud” may be used to refer to various types of arrangements that involve the cloud, this discussion refers specifically to arrangements that include both an on-premises software component and a cloud-based services component.
Typically, in a hybrid cloud arrangement, the on-premises software has standalone functionality and incremental functionality is obtained by accessing cloud-based services. For purposes of revenue recognition, a reporting entity that provides hybrid cloud offerings to customers may conclude, depending on the facts and circumstances, that (a) the license to on-premises software and the cloud-based services are each distinct or (b) the license to on-premises software and the cloud-based services comprise a single performance obligation. Refer to RR 9.3 for guidance on this assessment.
Generally, the development costs related to the licensed on-premises software transferred to customers in a hybrid cloud arrangement are subject to the guidance for externally marketed software in ASC 985-20. Costs that relate solely to the software used to provide cloud-based services would generally be subject to the guidance for internal-use software in ASC 350-40, unless the same software product is also licensed to customers, in which case the guidance for externally marketed software in ASC 985-20 would apply. Judgment may be required to distinguish between costs that relate to the licensed software and costs related solely to software used to provide a service.
The assessment of which guidance applies to software development costs related to a hybrid cloud arrangement is generally not impacted by the reporting entity’s conclusions regarding whether the software license is distinct for revenue recognition purposes. For example, the guidance for externally marketed software in ASC 985-20 would likely apply to a software license transferred to a customer even if it is not distinct as a result of being highly interdependent or highly interrelated with cloud-based services. As discussed in SW 1.3, ASC 985-20 applies to software that is sold to customers either as separate product or “as part of a product or process;” accordingly, the guidance is not limited to arrangements in which the reporting entity concludes the software is distinct. An exception would be an arrangement in which the software’s only purpose is to enable connection to the cloud-based service (see SW 1.4); however, this is not typically the case in hybrid cloud offerings.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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