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The update borrows the criteria from the guidance for software vendors and how they determine whether they have sold a software license or are selling a service. Under the proposed accounting standard, a hosting arrangement would only be accounted for as intangible internal-use software, and thus be capitalized, when these two conditions are met:

1. The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty, and

2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

A significant penalty is considered to exist when the entity is only able to take delivery of the software license by incurring either significant costs or a significant reduction in the utility or value of the software. For instance, if the only means to take delivery of the software that is being hosted is for the entity to create a server for the software and hire IT professionals to support the software, thus incurring a significant expense, the ability to take possession of the software would be considered to have a significant penalty.

If the customers arrangement does not meet both of the criteria, then the hosting arrangement is accounted for as a service contract, thus simplifying the application of accounting for hosting arrangements for entities

Most entities utilize software to manage their operations, or provided services to customers. Some entities purchase software licenses that are accounted for as a capitalized asset, while others access software through a hosting arrangement which is accounted for as an expense. The Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (ASU) to simplify how an entity distinguishes between the purchase of software that should be capitalized and obtaining software as a service through a hosting arrangement.

Internal-Use Software

Accounting guidance requires an entity to capitalize the cost of software acquired as an intangible asset and amortize the asset over its estimated useful life. If there are multiple elements purchased at the same time as the software, such as training, an entity is also required to allocate the purchase price to the multiple elements based on their relative fair value. The issuance of ASU 2014-05 Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40) Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement is expected to eliminate the diversity in practice in how to evaluate the purchase of software through a hosting arrangement.

May 2015

Simplifying the Accounting for Hosting Arrangements

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The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. Please contact your MHM auditor to further discuss the impact on your audit or audit report.

that had previously been evaluating capitalization of hosting arrangements under the internal-use software guidance.

The ASU is effective for public companies for annual and interim periods beginning on or after December 15, 2015. Nonpublic entities are required to adopt the ASU for annual periods beginning after December 15, 2015, and interim periods beginning after December 15, 2016. Early adoption is permitted. Entities may apply the guidance on a prospective basis to new arrangements and arrangements significantly modified after the effective date or adopt it retrospectively. Disclosure about the adoption, method of adoption and its impact on the financial statements is required.

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