How the standards do and don’t address an emerging area of practice

It’s often interesting when the standards have to be applied to a fact situation that didn’t exist, and wouldn’t reasonably have been foreseen, at the time they were developed. The Canadian IFRS Discussion Group recently addressed such a case – the accounting implications of cloud computing arrangements. Here’s the background:

“The following are some common examples:

• Software as a service – This arrangement is a software distribution model where applications are hosted by the service provider and the purchaser has access to the software through a network. The customer maintains all infrastructure and hardware.
• Platform as a service – This arrangement is a model where the cloud provider delivers both hardware and software tools needed for application development. The provider hosts the hardware and software such that the customer does not need to perform installation or purchase in-house hardware and software. This model does not replace the full infrastructure of the customer’s needs.
• Infrastructure as a service – This arrangement is a model where virtualized computing resources are provided over the internet. The third party provider hosts the hardware, software, servers, storage and other components on behalf of its users.

Outside of a software license being included in an arrangement, there are other types of possible fees for cloud computing. For example, there could be fees for service, software upgrades, support and maintenance, and internal and external consulting services. Other costs may include website development, development or acquisition of software to be used by the customer, infrastructure purchases and contract acquisition costs. These fees may be bundled together as one fee or individually quoted by the supplier. For example, a monthly fee may include upgrade rights and support and maintenance services.”

The group’s discussion brought out the following main points:

• A cloud computing arrangement may not fit into a specific standard and entities may need to look at the conceptual framework to determine whether the arrangement contains an asset. If the definition of an asset is met, an entity considers what type of asset the arrangement creates (for example, prepaid, other asset, or intangible asset).
• If the criteria in IAS 38 are met, a software license is capitalized as an intangible asset. However, the arrangement could contain multiple elements (for example, training costs). Guidance in IFRIC 4 should be considered to determine whether lease accounting applies.
• Some group members thought that fees incurred to enter into a cloud computing arrangement could be analogized to development costs and capitalized if the criteria set out in IAS 38.57 are met (that is, if the entity can demonstrate its ability to use or sell its interest in the arrangement, if it’s able to demonstrate how the intangible asset associated with these costs will generate probable future economic benefits and so on).
• Others struggled with this view, asking whether a resource exists that is controlled by the entity. If not, then the fees might either be recognized over the period during which they provide a benefit, or else expensed immediately, depending on the circumstances.

Overall, the group’s conclusion was a fairly broad one: “the Group’s discussion raises awareness on some of the different types of cloud computing arrangements that are emerging in practice and the complexities involved in determining which standard applies. One Group member suggested that this topic could be revisited by discussing one or more specific fact patterns as each type of cloud computing arrangement could be vastly different. No further action was recommended to the AcSB at this time.”

As the group mentioned at several points, lease accounting concepts will often be relevant in these situations. Of course, these concepts are in flux, with a new standard finally expected to be issued within the next few months. In the meantime, the IASB issued a project update on the definition of a lease. Under the new approach, a lease exists “when the customer controls the use of the identified asset throughout the period of use. This is when the customer has the right to obtain substantially all of the economic benefits from use of the identified asset throughout the period of use; and to direct the use of the identified asset throughout that period.”

The document contains some examples of applying the new standard’s concepts, including a couple of situations relating to contracts for network services. In one of these, the service provider supplies network services that meet a specified quality level, but the customer doesn’t operate the servers or make any significant decisions about their use; in the other, the customer decides which data to store on the server and how to integrate the server within its operations, and can change its decisions in this regard throughout the period of use. Under the new standard, the first contract doesn’t contain a lease; the second one does. No doubt though, the distinction will often be more difficult to make in practice. Especially, presumably, as the world evolves further, and comes up with new technological twists beyond our current imagination…

(See here for a subsequent discussion of this issue).

The opinions expressed are solely those of the author