Before IFRS, we had FRSs and FRS 10 set out that software which made a computer be productive was classed as a fixed asset. Software was viewed as being an integral part of the hardware. This standard was introduced in 1997 at a time when software was only starting to become a differentiated product to the computer or server it sat on. Even at this early stage, accounting standards were lagging behind what was happening in practice.

More recently, we have seen the move to cloud computing and software as a service (SaaS). To give an idea of the importance of cloud-based expenditure to the global economy, a Gartner survey from October 2021 estimated global IT expenditure of $4.47 trillion of which hardware was 18% with the remainder being spent on software, communications and data centres. Most of that expenditure will be spent on implementation and on-going services for cloud-based software, cloud hosted data, infrastructure as a service and platforms.

We have seen 2 recent IFRIC decisions on the topic of SaaS.

• The first agenda decision, published in March 2019, concludes that SaaS arrangements are likely to be service arrangements, rather than intangible or leased assets. This is because the customer typically only has a right to receive future access to the supplier’s software running on the supplier’s cloud infrastructure and therefore the supplier controls the intellectual property (IP) of the underlying software code. On its own, may would see this as a logical conclusion.

• The second agenda decision, published in April 2021, deals with specific circumstances in relation to configuration and customisation costs incurred in implementing SaaS. In limited circumstances, certain configuration and customisation activities undertaken in implementing SaaS arrangements may give rise to a separate asset where the customer controls the IP of the underlying software code. For example, the development of bridging modules to existing on-premises systems or bespoke additional software capability. In all other instances, the IFRIC agenda decisions is that configuration and customisation costs will be an operating expense. They are generally recognised in profit or loss as the customisation and configuration services are performed or, in certain circumstances, over the SaaS contract term when access to the cloud application software is provided.

The March 2019 decision largely endorsed what was general practice. Companies were receiving a service over a period and companies agreed with the substance of that.

The April 2021 decision however has been heavily debated. In discussions with many preparers of financial statements, we have not across few who agree with the decision. While CEOs are talking about their digital transformation, this IFRIC decision tells the CFO how he should account for the up-front configuration and customisation of that digital transformation, which in most cases is to expense it as incurred. This is at odds with a simple view expressed by many that the benefit of these costs accrue over a period so why would they not be capitalised?

The April 2021 decision however is based off various principles, which in aggregate gives a decision at odds with the view of many CFOs.

To understand their decision, it is useful to summarise the difference between on-premise software and software as a service, as per the below table.

The IFRIC observed, in March 2019, that a right to receive future access to the supplier’s software running on the supplier’s cloud infrastructure does not, in itself, give the customer any decision-making rights about how and for what purpose the software is used. Nor does it, at the contract commencement date, give the customer power to obtain the future economic benefits from the software itself and to restrict others’ access to those benefits. Consequently, the IFRIC concluded that a contract that conveys to the customer only the right to receive access to the supplier’s application software in the future is neither a software lease, nor an intangible software asset, but rather a service the customer receives over the contract term.

Some scenarios were set out where the SaaS expenditure may meet the criteria for being an intangible asset including where the customer is allowed to take ownership of the asset during the contract or where the customer is allowed to run the software on their own hardware (Consistent with FRS 10 back in 1997!).

The April 2021 decision led on from this train of thought, which can be summarised as- “if you incur expenditure on connecting your business to a cloud-based solution, you do not own that asset and as it is not your asset so you cannot capitalise costs you incurred in customising or configuring that software."

So, the question arises, are there any scenarios where an entity may be able to capitalise configuration and customisation services? The simple answer is yes and arises when the entity can control the software. This may arise where the customer has the right to keep the software on-premise on their own servers or behind their own firewall. For on-premise software, the activities likely represent the transfer of an asset that the entity controls because it enhances, improves, or customises an existing on-premise software asset of the entity.

Whilst the IFRIC only discussed configuration and customisation activities of implementing a SaaS arrangement, the full SaaS implementation includes a range of activities. The following table illustrates some examples (not all-inclusive) of typical costs incurred in SaaS arrangements and the likely accounting treatment of each.

Practical Implications

Beyond, complying with the IFRIC meeting agenda decision, there are some considerations for the many companies who have or are undertaking SaaS implementation projects. These include.

• IAS 8 requires an entity to apply an accounting policy change retrospectively as if the entity had always applied the new policy. Companies may need to determine if they have capitalised costs which the IFRIC may suggest should not have been capitalised and if this impacts comparative periods.
• Budgetary decisions may have been made based on digital transformation projects being largely capital in nature, however with such costs now being expenses, it may impact performance when reviewed against budget or external forecasts, and
• Some banking covenants contain EBITA or capital expenditure requirements so the impact on covenant compliance may need to be assessed.

Conclusion

It is interesting that while the IFRIC Committee agreed with the interpretation from April 2021, out of the 19 comment letters received, only five respondents agreed with the analysis and conclusion. This would suggest that may see an issue with practicality in the decision.

Many companies we have spoken to, have considered the long-term benefit of such costs as being the reason they view capitalisation as the appropriate route for configuring and customising software. Others have cited the fact it is an upgrade on the previously on-premise capitalised costs so hence appropriate to capitalise.

As we continue to use assets such as SaaS or other cloud-based solutions, it will be interesting to see how GAAP develops to recognise that software and hardware are no longer interdependent. Other topics such as accounting for development of open-source software, open network co-operation and platform arrangements will be interesting when they start to become material in the business world.

Written by Richard Howard, partner, and Ryan Mathers, manager, in Deloitte’s Technology, Media and Telecommunications industry group.

This article first appeared in Accountancy Ireland on 1st February 2022.