New guidance from the Financial Accounting Standards Board on accounting for cloud computing costs will take effect for public business entities in 2020 and provide a welcome change for companies incurring significant implementation costs as corporate computing continues to migrate to the cloud.

FASB issued Accounting Standards Update No. 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to reduce diversity in practice in accounting for costs of implementing cloud computing arrangements that are service contracts.

While previous guidance did not address accounting for implementation costs for hosting arrangements that do not contain a software license, accounting for all such costs is now aligned—regardless of whether a license to the hosted software is conveyed. In addition, rather than expensing certain cloud-related implementation expenses, they can now be deferred and amortized by applying ASC 350-40: Internal Use Software.

ASU 2018-15 amends the definition of a hosting arrangement as one where the customer accesses and uses software as needed but does not currently have possession of the software. It makes the requirements for capitalizing implementation costs in hosting arrangements more consistent with accounting for costs relating to developing or obtaining internal-use software, including the types of costs (and the project stages) that can be capitalized.

Previously, ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, was issued to clarify (and potentially simplify) the accounting for cloud computing costs, including whether the arrangement contained a software license. If the arrangement did have a software license, the cost of the license was generally capitalized and amortized based on the guidance in ASC 350-40 and a liability was recorded for future license payments due. If the arrangement did not contain a license, the fees for the hosting service were expensed as incurred.

Companies were struggling with having to expense significant investments—as they were considered service contracts and not software licenses—since they were not able to separately download and operate the software on their own hardware. Recent cloud-based solutions for the new lease accounting standard added to this concern, compelling the board to reconsider its prior guidance and issue ASU 2018-15.

Under ASU 2018-15, certain costs in the application-development phase will be capitalized and amortized over the term of the hosting arrangement (begins when the component is ready for intended use through the noncancelable period of the arrangement, plus considerations of options to extend or terminate) on a straight-line basis unless another basis is more representative of the period of benefit from access to the software. Implementation costs incurred in the preliminary project and post-implementation operation stages will be expensed.

The new standard also includes guidance on the presentation of the implementation costs. Capitalized costs are presented on the balance sheet on the same line as prepaid fees for the related hosting arrangement. Expenses for amortization of these costs are included in the income statement in the same line as the fees for the hosting arrangement, and the payments for the costs are presented in the cash flow statement in the same manner as the fees paid for the hosting arrangement. ASU 2018-15 clarifies that capitalized implementation costs are not long-lived assets and that their amortization expense is not included with depreciation and amortization of property and equipment and intangible assets.

This ASU also requires the capitalized costs be evaluated for impairment based on ASC 350-40 and for abandonment based on ASC 360-10. Disclosures relating to hosting arrangements that are service contracts should include the nature of the arrangements, disclosures required by ASC 350-40 for internal use software, and disclosures required by ASC 360-10, treating the capitalized implementation costs as a separate class of depreciable assets.

ASU 2018-15 takes effect for public business entities for fiscal years starting after Dec. 15, 2019, and interim periods within those fiscal years. For all other entities, it is effective for annual reporting periods beginning after Dec. 15, 2020, and interim periods within annual periods beginning after Dec. 15, 2021. Early adoption is permitted. Adoption can be retrospective, or the amendments can be applied prospectively to new implementation costs incurred after the adoption date. Transition disclosures depend on the transition method selected.