The Accounting Change that May Affect SaaS Arrangements

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Whether to treat customisation costs in a SaaS or cloud computing arrangement as assets or expenses has long been a grey area for companies investing in software.

However, the International Financial Reporting Interpretations Committee (IFRIC) has now provided clarity, announcing that these costs would ordinarily be expensed rather than capitalised as intangible assets.

This determination could have implications for companies seeking SaaS arrangements, and for how flexible SaaS companies need to be in offering their services.

The current situation

In the traditional model of buying software application licences, the customer controlled and held the software as an intangible asset. This asset would then be depreciated over its useful life.
In a SaaS arrangement, the customer only has rights to access the software, which is controlled by the supplier. So in general, SaaS costs are treated as an expense by the customer. The Accounting Change that May Affect SaaS Arrangements

The ambiguity in the Accounting Standards has been around the additional costs for customisation and configuration of the software for a customer. The IFRIC has determined that in the majority of cases, it would not be possible for the customer to recognise these costs as intangible assets.

There are some possible exceptions. Examples might include where additional code is written to allow existing in-house software to connect to cloud-based software applications, or where a customer-controlled resource is created that is separate from the software. Our IFRS News update has more information on this.

Implications of the announcement

Customers that have previously capitalised these costs may now need to switch to expensing the costs, treating them as operating services received. It is important for SaaS companies to be aware of this impact on customers that request customised services. The Modern Manufacturing Initiative (MMI) is a $1.3 billion initiative targeted at all businesses growing Australia’s Manufacturing capacity, building scale, and supply chain resilience.

“Some technology companies could find their clients being surprised by how this works and needing to explain it to them,” says RSM Assurance and Advisory Partner, Mathavan Parameswaran.

The situation could also affect decision making and forward planning. For example, a customer planning an IT upgrade might have to factor in the effect of expensing these costs in the 1-2 years ahead, and adjust accordingly.

SaaS companies need to consider whether some customers might want to construct a deal involving a one-off licence arrangement, which in this sort of situation would ordinarily allow customers to capitalise their IT investment.

However, this may not be the optimal outcome for SaaS companies focused on recurring revenue and cashflow due to the ‘uneven’ revenue recognition this scenario creates.

Seeking professional advice on the way forward

If you would like advice on how to proceed in light of the IFRIC determination and the impact it might have on your customers' dealings with your company, feel free to talk to the RSM team.