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Closing the "Cap Gap" Between Cloud CIS and On-Premise CIS

Posted in: Blog

At the ETS18 event in Austin, Texas, Vertex sponsored a panel discussion addressing newly proposed updates to FASB accounting standards regarding cloud computing costs. As the CFO of Vertex, I was excited to participate as a panel member.

Specifically, our discussion revolved around how the evolution of GAAP treatment of CapEx versus OpEx costs that are incurred during the implementation and maintenance periods for certain cloud-based software solutions. Generally speaking, GAAP pronouncements have been catching up to the industry acceptance of cloud-based investments as long-lived assets.  While the evolution of GAAP has been slow, it is picking up the pace and the trend is clear - expenditures to establish cloud-based solutions are now assets that are capitalizable.

The starting point was the long-standing GAAP standard ASC 350-40 which is the basis for capitalizing internally developed software as an asset. The initial bridge connecting ASC 350-40 to Cloud Computing Arrangements (CCA) came in April 2015 when the FASB issued Accounting Standards Update (ASU) No. 2015-05.  ASU No. 2015-05 allowed the capitalization rules of ASC 350-40m to be used for implementation element of CCA investments if the arrangement included a software license.  

Two key criteria had to be met. The customer must be able to:

  • Take possession of the software (obtain licensing) without significant penalty, and
  • Be able to run the software on its own hardware or a third-party vendor apart from the developer.

While this was a good start, it fell a bit short as it didn't address the capitalization of implementation costs for CCA’s when such an arrangement did not include a  software license. We all know that most cloud-based solutions do not include a perpetual software license but instead offer a right to use license during the term of the subscription.  So, while ASU No. 2015-15 was a huge step in the recognition of CCA as a capitalizable intangible asset, it fell a bit short.

However, in March 2018, FASB published a proposal to address this concern. The proposed update expands the scope of 2015-05 to allow capitalized implementations when the CCA does not include a software license. This proposal will align the requirements for capitalizing implementation costs for cloud-based service contracts with the market expectation on how these products are offered and used by customers.   

If adopted, we would see a significant expansion of capitalization capabilities for cloud-based arrangements, regardless of licensing agreements. With this proposal, the ability to capitalize the implementation costs of virtually any CCA would be solidified.  This allows a complete connection between the original accounting standard of ASC 350-40, which required internally developed software to be capitalized as an asset, and the new market reality of cloud-based solutions.

These accounting developments allow utilities more leeway in determining which CCA costs they will capitalize and which they will expense, regardless of whether a software license is purchased from the developer. These newly issued standards essentially make the decisions the same for on-premise, licensed software solutions, and Cloud Computing Applications. Therefore, with these changes, the one accounting hurdle that may have dissuaded some utilities from adopting more efficient and more effective CIS cloud solutions is about to be cleared.

At Vertex, we're already ahead of the curve. With our VertexOne CIS, we resell the SAP license to our customers upfront, as part of the implementation process. In other words, it is designed to allow utilities to capitalize these costs under the current 2015-05 guidance. And, should the newly-proposed FASB update pass, we’ll have the flexibility to make even greater enhancements that allow VertexOne to meet your utility’s needs to capitalize its CCA costs.

 

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