Accounting Changes Impact Cloud Computing

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Two months ago, the U.S. Financial Accounting Standards Board issued an Accounting Standards Update that impacts the accounting of software bundled with cloud services.

Ernst & Young concluded in its treatise on this topic that, "A cloud computing customer that determines it is acquiring a software license will no longer consider the lease guidance to determine the accounting for the software license and would instead account for it in the same manner as other licenses of intangible assets."

Consider a service like Microsoft Office 365, which can be provided as an Enterprise Agreement Subscription (EAS). With the EAS, customers have the ability to use their Office, Exchange, and SharePoint licenses either on-premise or in the Microsoft Office 365 cloud. The Accounting Standards Update suggests in this scenario that the cloud software component of the EAS (Exchange, SharePoint, Office) would not be subject to leasing accounting treatment, where the rest of the contract (Windows OS, Systems Center, etc.) could be.

This is just the latest example of the befuddling accounting intricacies that impact cloud services as the United States and the rest of the world continue to tweak technical accounting standards to accommodate cloud subscription models.

The long-promised, long-threatened consolidation of GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) is another significant accounting change that could impact cloud services. The United States uses GAAP, but nearly everyone else in the world is using IFRS.

The governing bodies negotiating GAAP/IFRS convergence have leaned towards considering the equipment covered by a service contract (such as a server) to be a lease if the equipment is identified by the service contract, controlled by the customer, and critical to the delivery of the service. This would have a significant impact on a company's appetite for "bare-metal" IaaS cloud solutions. A company procuring this type of IaaS service would need to quantify the separation of the "server lease" from managed services in the contract (monitoring, patching, support, etc.), or they would need to add the entire cost of the contract on its balance sheet. This would negate one of the financial accounting benefits of cloud, and make the company less desirable to investors.

Fortunately, we may not need to worry about this in the near-term. Despite the SEC's promise for global standardization in its 2010 - 2015 Strategic Plan, the same organization has more recently drafted a 2014 – 2018 Strategic Plan, which suggests distancing GAAP from IFRS rather than converging with it. It would seem that the momentum in the U.S. for international convergence has stalled, no differently than America's desire to fully embrace the metric system.

Time will tell what curveballs the world's accounting czars will throw at the cloud. There are many changes being considered specific to cloud services, as well as broader changes that would impact the desirability of specific cloud solutions. The guidance I give to my clients on this topic is to ensure that cloud buyers in their organization consult with their financial teams prior to procurement of cloud services to determine what can be capitalized vs. expensed.

- Jay Keyes, Vice President of Cloud Advisory Services, NTT DATA, Inc.

Post Date: 6/29/2015

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