Despite rapid growth in cloud services, global revenues for which Gartner pegs to hit $331 billion by 2022, updated cloud computing accounting rules have been a back-burner issue for many companies.
More significant new accounting standards — for leases, credit losses, and hedges — that have been commanding CFOs’ attention recently could be to blame.
However, the updated cloud computing accounting rules — the Financial Accounting Standards Board’s ASU 2018-15 — will change how CFOs at companies looking to deploy or already engaged in cloud computing arrangements approach these investment decisions.
The new standard — effective for public companies in their fiscal year beginning on or after Dec. 15, 2019 — requires companies to capitalize certain costs associated with implementing a cloud arrangement.
Historically, companies have had to expense most of those costs as incurred. The new standard generally brings the accounting for implementing cloud arrangements in line with that for internal-use-software costs, which have always been capitalized.
There will be nuances in how the capitalization of costs for cloud computing arrangements, internal software, and hybrid arrangements are reflected on the balance sheet and profit & loss statement.
That’s likely to push companies to have more thoughtful discussions on the best way to deploy to the cloud.
Following are three key considerations for CFOs as they work through implementation of the new guidance.
EBITDA and Balance Sheet Metrics
Depending on a company’s industry or business strategy, some CFOs may be more interested than others in how certain metrics impact their investment decisions under the new standard.
Two examples of key metrics that CFOs may monitor in relation to this standard are earnings before interest, taxes, depreciation, and amortization and balance sheet metrics.
Until now, cloud-service arrangement costs typically have resulted in a reduction in EBITDA when incurred. The new guidance defers some of these costs as assets and requires them to be recognized over the period of service, thereby reducing the immediate impact on EBITDA.
Depending on the type of cloud deployment a company is running or exploring, and the breakdown of capitalized versus operating costs under the new guidance, some CFOs may find that a cloud service arrangement or hybrid solution could now be a more appealing option, since the immediate impact to EBITDA can be somewhat mitigated.
For companies where balance sheet metrics such as current ratio or working capital are important, the new guidance could provide CFOs and CIOs with an additional consideration in their on-premise-versus-cloud decision process.
Under current guidance, certain qualifying costs associated with on-premise solutions are capitalized as intangible assets during the implementation period while costs associated with cloud services were expensed. Under the new guidance, cloud arrangement costs may also result in capitalized implementation costs presented in a different location on the balance sheet.
Further, depending on the size of cloud projects and their related financial implications, it may be worth considering how best to communicate the impacts of the updated standard to stakeholders such as investors and audit committees.
Collaboration with the CIO
Given the nuances of the new standard, it is important for the CFO and CIO to make sure that members of their respective organizations are collaborating to maximize the deployment of cloud solutions going forward.
CIOs will need to involve the finance department, especially those colleagues closest to financial planning and analysis, early on, as internal budgeting could have an impact on the type of solution the company ultimately pursues.
Depending on how new capitalized costs impact ongoing budgeting, CIOs and CFOs may find that the ability to defer costs makes moving forward with cloud projects more attractive.
Data Gathering and Business Processes
While many companies already have policies in place to account for internal-use software based on existing guidance, these policies historically have not applied to cloud computing arrangements.
In addition, companies will need to adapt existing processes or establish new ones to gather the right data for reporting. This information could come from the vendor, internal teams including legal, or other sources.
While the CFO may be able to leverage existing processes for data gathering, it’s more likely that new processes will need to be established to ensure the finance team has the right data to report under the new cloud computing accounting guidance — and, importantly, drive investment discussions with senior leadership.
Companies may look to potentially leverage contract review workflow or a center of excellence, similar to what many organizations implemented with adoption of other recent new standards, such as lease accounting.
Companies that don’t have to deal with this issue in short order — for example, private companies that are not required to comply until 2021 but are permitted to early-adopt, and companies that aren’t currently using cloud — should still pay close attention to this standard, given the rapid growth expected in cloud adoption.
Although many companies still use on-premises solutions today, many others are moving to the cloud or have deployed hybrid infrastructure arrangements. We’re seeing a range of business factors driving cloud computing growth and even accelerating it.
This growth is unlikely to abate making this an accounting standard that more and more companies will need to get comfortable with in the near term, especially when considering how to drive better investment decisions related to technology.
Questions for CFOs to Consider
- Is my finance team working closely with our technology team to support them as they think through the financial statement impacts of technology decisions?
- Do we have appropriate processes and controls in place to accurately account for cloud computing and internal use software arrangements?
- Are accounting policies and related judgments around cloud computing arrangements appropriately vetted with stakeholders, including auditors?
- Do we have the appropriate technology solutions in place to support the accounting for cloud computing arrangements?
- Do we have a communications plan to generate awareness for stakeholders, including the impact cloud computing accounting will have on key performance metrics?
Chris Chiriatti is an audit and assurance managing director at Deloitte & Touche LLP. Matt Hurley is a senior manager and Sean Torr a managing director with Deloitte Risk & Financial Advisory, which is part of Deloitte & Touche LLP.