Cloud computing implementation costs may impact P&L accounts for year-end

ASX200 companies may have to put expenditure incurred during the implementation of a cloud computing supplier arrangement into their profit and loss.

KPMG warns that many ASX200 companies may have to put expenditure incurred during the implementation of a cloud computing supplier arrangement into their profit and loss account for their 30 June 2021 year-ends, following a decision by international accounting standard-setters.

It is estimated that Australian companies spent more than $1bn on cloud in 2020, with the figure expected to grow as cloud-based computing or Software as a Service (SaaS) arrangements continue to rise in popularity as working practices change following COVID-19.

A customer in a cloud computing arrangement often incurs various up-front implementation costs, and currently many companies capitalise the costs of configuring or customising a supplier’s application software in a SaaS arrangement.

The new global ruling by the IFRS® Interpretations Committee (IFRIC) – which is immediately binding in Australia – means that these costs will now likely be expensed as a service contract. It has immediate effect and will be retrospective, meaning that any costs capitalised with respect to cloud computing arrangements in prior years may need to be adjusted against the company’s retained earnings.

Andrew King, CFO Advisory Partner, KPMG, said: “We advise that Australian companies which use cloud computing or SaaS arrangements urgently consider the implications of this ruling.  For those entities with a 30 June financial year end there is limited time to understand what amounts have been capitalised previously and to perform an assessment on how they should be treated under the new guidance.”

“If a company has an April or May financial year end and its financial statements are yet to be signed, they will also need to apply the changes.”

“The likely outcome is more expense being recognised in a company’s profit or loss account during the installation or implementation phase of a cloud computing arrangement, which is typically when the customisation or configuration work is performed. Costs for this work, data migration services, testing or training costs are likely to be expensed.”

“In the instance that a company is unable to apply the changes by 30 June 2021 or the time its financial statements are signed – for example because there is no time to assess the potential impact, or the impact is so large that more time is needed to calculate the adjustments – companies will need additional disclosures in the financial statements on the potential implications and should be prepared to have this discussion with their auditor.”

Cloud-based computing or SaaS arrangements are continuing to grow in popularity in Australia and overseas at a time when COVID-19 has re-focused 21st century ways of working. The focus of Australian Boards on cost-out strategies and demanding flexibility in their organisation’s IT footprint, together with a focus from software vendors of pivoting to SaaS offerings means their prevalence will only rise, KPMG believes.

The timing of when the costs for configuration or customisation services are recognised under the new ruling will be dependent on who provided the service and whether the service is ‘distinct’ in the context of the cloud computing arrangement.

Andrew King added: “The ruling is retrospective, which will also lead to companies having to reassess previously-capitalised costs and consider whether they actually met the identifiability and control criteria to be recognised as intangible assets. If not, those costs may have been incorrectly capitalised in the past under the new guidance. Any costs capitalised with respect to cloud computing arrangements in prior periods may need to be adjusted against the company’s retained earnings.”

KPMG expects this ruling to be a catalyst for companies to review and update their accounting policies with respect to IT investment, including revising their Opex/Capex existing decision criteria. Given the accounting standard that relates to capitalising IT software costs (AASB 138 Intangible Assets) has not changed significantly in more than a decade, this review will be timely for many companies.

Andrew King said: “This ruling may have a flow on impact on planned IT investment budgets which may have been prepared on the basis that certain implementation costs associated with new cloud arrangements can be considered Capex. Given the next financial year is now less than a month away, many companies will have finalised their IT investment budgets for next year and these may now need to be revisited.  It will also lead to a change in how future business cases for investment are prepared.”