Analysis by Christos Antonopoulos and Nektaria Petaroudi

Determining the appropriate accounting treatment for SaaS (Software as a Service), or more broadly, cloud computing, is a complex issue under IFRS. To address this, the IFRS Interpretations Committee (IFRIC) has issued two agenda decisions that clearly set out the correct approach to accounting for both the fees paid to the cloud service provider and the corresponding initial implementation costs. It should be noted that no amendments to IFRS were deemed necessary, as the Committee considered that sufficient guidance already exists within existing accounting standards. This article aims to summarise the accounting policies related to software as a service.

What Is Cloud Computing?

Cloud computing is a technology that uses the internet and centralised remote servers to store large volumes of data and software applications. Software vendors are responsible for controlling and maintaining the servers, databases, and application code. This system allows consumers and businesses to use applications via the internet without requiring any installation, thereby providing them with access to all their files at any time and from any location. In some cases, the customer’s right to access the hosted software creates an intangible asset (e.g., a software licence). In others, no software intangible asset is acquired. These cases are commonly referred to as SaaS.

IFRIC’s Positions

During consultation on the matter, the Committee identified the application of different accounting approaches regarding the initial configuration and customisation (or implementation) costs related to cloud computing arrangements, which varied across companies depending on their internal policy. These policies ranged from full expensing to full capitalisation of all costs.

In March 2019, IFRIC published an agenda decision distinguishing between cases where the customer receives a software intangible asset and those where they do not, and which are therefore treated as service contracts. Subsequently, in April 2021, the same Committee issued guidance on the accounting treatment of initial implementation costs arising from a SaaS arrangement.

Software Asset or Service?

The March 2019 agenda decision examines how a cloud computing arrangement in which the customer contracts to pay a fee in exchange for the right to access the vendor’s application software for a specific period, should be accounted for. The question raised here is whether the customer receives a software asset at the inception of the contract (under IAS 38 and IAS 16) or receives a service during the contract term.

A cloud software arrangement generally does not give rise to a lease under IFRS 16. This is because the right to future access to the vendor’s software running on the vendor’s cloud infrastructure does not in itself provide decision-making rights regarding the manner and purpose for which the software is used.

Furthermore, the right to future access to the vendor’s software does not grant the customer a right of control, nor the ability to obtain future economic benefits derived from the software itself, nor to restrict others’ access to those benefits. Therefore, SaaS arrangements generally do not create an intangible asset.

In conclusion, where a SaaS arrangement does not give rise to a software lease nor create an intangible asset controlled by the entity, the right to future access to the vendor’s application software constitutes a service contract. In this case, the company recognises the related costs at the time it receives the SaaS, i.e., during the SaaS period. If a company prepays for SaaS, this is recognised as a prepaid asset representing the customer’s right to receive future services. Conversely, a company recognises a financial liability if it receives access to the software before paying for it.

However, in certain cases a company may reach a different conclusion. The characteristics of an arrangement that may indicate the company acquires control of a software intangible asset include:

• The customer’s right to obtain a copy of the software and run it on the company’s or a third party’s computing infrastructure, or
• Exclusive rights to use the software or ownership of the intellectual property for customised software, in which case the software vendor cannot make the software available to other customers.

Initial Implementation Costs: Expense or Capitalise?

The successful implementation of a SaaS arrangement may involve various upfront implementation costs for the company (e.g., testing, conversion, data migration, configuration costs, etc.). The accounting treatment of initial implementation costs depends on whether the company receives a software intangible asset as defined under IAS 38.

Where the arrangement creates a software intangible asset: If the company recognises an intangible asset through a SaaS arrangement, the cost of that asset is determined in accordance with IAS 38. Specifically, the cost of the asset includes directly attributable costs of preparing the software for its intended use. As with an on-premise software licence, many implementation costs are capitalised as part of the cost of the software asset (e.g., payroll costs, installation, testing, etc.).

Where the arrangement does not create a software intangible asset: Where no intangible asset is recognised by the company, the initial implementation costs are expensed as the related implementation activities are carried out, not when the customer gains access to the SaaS service to which those costs relate. Exceptions to this treatment arise when: the implementation services are not distinct from the SaaS; or the implementation costs create a separate tangible or intangible asset (e.g., the purchase of IT equipment).

Impact of IFRIC Interpretations on Businesses

Entities applying IFRS must follow IFRIC guidance. When an entity’s current accounting practice must change as a result of an IFRIC decision or interpretation, this results in a change in accounting policy. Such changes are generally accounted for retrospectively, meaning that balances disclosed in prior periods must be restated when the changes are material.

In addition, specific disclosures are required for changes in accounting policies. IFRIC decisions do not have an effective date; however, the expectation is that entities will adopt the resulting changes in a timely manner (by 31 December 2021 per relevant notification). Consequently, entities should assess the impact of the relevant decisions and reflect the required changes in their financial statements as soon as possible.

Illustrative Impact of Retrospective Restatement on Financial Statements

In the year of SaaS implementation, a reduction in profits is expected (with a corresponding impact on retained earnings), arising from the initial implementation costs incurred in the early stage of the process. In subsequent years, during the SaaS contract period, current costs incurred for SaaS access will be recognised as operating expenses with no further depreciation charges, which may in some cases lead to an increase in profits.

Conclusion

Rapid and intense technological advances require a corresponding response and adaptability at the accounting level, in order to ensure the smooth operation of companies and their broader business growth. Companies must leverage new transactional capabilities, promptly integrate appropriate accounting, and other, policies, and be able to modify standard processes when required. As our friends on the other side of the Atlantic say: ‘Your issue is not the issue. Your reaction is the issue.’