Understanding the accounting for configuration or customisation costs in Software as a Service (SaaS) cloud-based arrangements

In April 2021, the IFRS Interpretations Committee (Committee) issued an agenda decision regarding how to account for configuration or customisation costs associated with software purchased from a supplier in a Software as a Service (SaaS) arrangement (i.e. a cloud-based computing arrangement), specifically considering:

1. Whether to recognise a separate intangible asset for the costs of configuring or customising the service provider’s application software to which the entity (customer) has access; and
2. Where an intangible asset is not recognised, how the entity (customer) should account for the configuration or customisation costs.

This agenda decision followed a previous decision, made in March 2019, in which the Committee concluded that for many SaaS arrangements an entity (customer) receives a service, rather than an intangible asset, because generally the entity only receives a right to the SaaS provider’s application software.

With the continuing and increasing use of companies using cloud-based arrangements within their businesses, the Committee’s conclusion could have significant implications for some companies, specifically being required to expense configuration or customisation costs that were previously capitalised.

Decision Tree Diagram

We have produced a decision tree diagram to help support the application of the requirements and demonstrate the implications of the agenda decision.

https://blogs.mazars.com/mindthegaap/files/2021/11/SaaS-Decision-Tree-Diagram.pdf

When is it effective?

As this is an agenda decision provided by the IFRS Interpretations Committee, it is effective immediately from when the decision was announced in April 2021.

What it relates to?

In the fact pattern discussed by the Committee, the SaaS arrangement between the entity (customer) and the service provider (supplier) gives the entity the right to receive access to the service provider’s application software over a specified contract term.

The contract therefore does not provide the entity with a software asset (i.e. an intangible asset is not recognised in accordance with IAS 38 Intangible Assets (IAS 38) because, as the Committee concluded in March 2019, the entity does not control the software being configured or customised and those activities do not create an asset that is separate from the software) and therefore the access to the software is a service. The entity incurs costs of configuring or customising the service provider’s application software to which the customer receives access.

In the Committee’s decision, such costs are defined as follows:

• Configuration costs – the setting of various ‘flags’ or ‘switches’ within the application software, or defining values or parameters, to set up the software’s existing code to function in a specified way.
• Customisation costs – modifying the software code in the application or writing additional code, thereby generally changing, or creating additional, functionalities within the software.

In providing the conclusion, the Committee analysed the following:

1. Should the entity recognise an intangible asset in relation to configuration or customisation of the application software?

An entity would not recognise an intangible asset where it does not control the software being configured or customised, and those configuration or customisation activities do not create a resource controlled by the entity that is separate from the software (as is the case in the request). However, where this is not the case in a SaaS arrangement, the assessment of whether configuration or customisation of the software results in an intangible asset should depend on the nature and output of the configuration or customisation performed, for instance considering the identifiable and recognition criteria set out within IAS 38.

An entity should recognise an item as an intangible asset when the entity demonstrates that the item meets both the definition of an intangible asset and the recognition criteria in IAS 38.21-23. IAS 38 defines an intangible asset as “an identifiable non-monetary asset without physical substance”. IAS 38 notes that an asset is a resource controlled by an entity and IAS 38.13 specifies that an entity controls an asset if it has ‘the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits’.

In some circumstances, however, the Committee’s analysis noted that the arrangement may result in, for example, additional code from which the entity has the power to obtain the future economic benefits and to restrict others’ access to those benefits. In that case, in determining whether to recognise the additional code as an intangible asset, the entity should assess whether the additional code is identifiable and meets the recognition criteria in IAS 38.

2. Where an intangible asset is not recognised, how should the entity account for the configuration or customisation costs?

Where an intangible asset is not recognised for the costs of configuration or customisation of the application software, then the costs should be recognised as an expense, in accordance with IAS 38.68-70, when the entity receives the configuration or customisation services. This is when they are performed by the service provider in accordance with the contract to deliver them to the entity and not when the entity uses them to deliver another service.

When recognising the costs as an expense, the entity should refer to the requirements within IFRS 15 Revenue from Contracts with Customers (IFRS 15), which deal with a similar and related issue, to determine when the service provider (or a sub-contracted provider) performs the configuration or customisation services in accordance with the contact to deliver services, and hence when the expense should be recognised, specifically:

• if the services are distinct, then the entity should recognise the costs as an expense when the service provider configures or customises the application software (i.e. expense immediately); or
• if the services are not distinct (because those services are not separately identifiable from the entity’s right to receive access to the service provider’s application software), then the entity should recognise the costs as an expense when the supplier provides access to the application software over the contract term (i.e. recognise a prepayment and expense the costs over time).

However, where the contract to deliver the configuration or customisation services to the entity is with a third-party supplier, then the entity should recognise the costs as an expense when the third-party supplier configures or customises the application software (i.e. expense immediately)[1].

[1] A current area of discussion surrounds whether a third party may be considered to be acting as an agent of the SaaS service provider in providing the configuration or customisation service. This will depend upon the specific facts and circumstances. Where this is the case, the costs should be recognised as a prepayment and expensed when the SaaS service provider provides access to the application software over the contract term, this being where the configuration or customisation service is not deemed to be distinct from the SaaS arrangement.

What are the disclosure requirements?

The entity should disclose its accounting policy for configuration or customisation costs, in accordance with paragraphs 117-124 of IAS 1 Presentation of Financial Statements, when that disclosure is relevant to an understanding of its financial statements.

Additionally, where there is a change in accounting policy (see below for further information), then the disclosure requirements set out in paragraph 29 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors must also be complied with. In summary, this requires:

• The change in the accounting policy to be described and explained clearly within the notes;
• The amount of the adjustment(s) for each line item(s) affected by the change, for all periods affected (when prior periods are affected, this may therefore require a restatement of opening reserves within the Statement of Changes in Equity); and
• The impact on basic and diluted earnings per share, if IAS 33 Earnings per Share is applicable.

What are the first-time application requirements?

As this is an agenda decision provided by the IFRS Interpretations Committee, it is effective immediately from when the decision was made in April 2021.

Entities are allowed sufficient time to assess and implement any changes that are necessary. The time taken by an entity to assess the full effect of any change on their business will vary on an entity-by-entity basis depending on the specific facts and circumstances, for instance depending upon the complexities and scale of the change required. Where an entity has not had sufficient time, the financial statements (or interim reporting as applicable) should disclose and explain the process being carried out, the timing of any expected change and an estimate of the financial impact.

Will retrospective application be required?

IFRS Interpretations Committee agenda decisions provide explanatory information and material which may result in an accounting policy change in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (IAS 8). Accounting policy changes must be applied on a retrospective basis (i.e. by restating prior year information).

As such, following this agenda decision, an entity may be required to restate the accounting treatment applied for configuration or customisation costs if, for example, they were previously capitalised under IAS 38.