Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.  This subtopic provides guidance on which Cloud Computing Arrangement (CCA) implementation costs should be capitalized as an asset or expensed.  ASU 2018-15 is applicable to public business entities starting in 2020 and all other entities in 2021.  

CCAs, in general, are third-party service contracts.  There are three types of CCAs:

1. SaaS: Software as a Service - web-based delivery of applications managed by a third-party vendor.

2. PaaS: Platform as a Service - third-party provided framework for a team of software developers to create and manage customized applications.

3. IaaS: Infrastructure as a Service - third-party provided on-demand, self-service access to highly scalable and automated computing resources.     

When a CCA is hosted by a vendor, through a service contract, there are certain implementation costs that are capitalizable in a similar way that internal-use software license implementation costs are capitalizable.  There are several business benefits to using a CCA for software needs including reduced capital expense outlays as well as a more flexible information technology (IT) environment for employees. The updated accounting guidance for implementation costs is another business benefit that makes the use of CCAs more attractive to businesses.  

Prior to this update, implementation costs were not addressed; prior guidance distinguished between arrangements including a software license and arrangements only through a CCA hosted service.  The recent update provides balance sheet, income statement and statement of cash flows classification information for the capitalized implementation costs and the associated amortization expense.  The update also provides clarification of any confusion from the previous guidance related to service contract implementation costs.

For CCAs that include a software license, the new guidance details which costs should be capitalized including the cost to acquire the software license and the related implementation cost.  For CCAs that include a software license, the new guidance details which costs should be capitalized including the cost to acquire the software license and the related implementation cost. This aligns with the recent update to ASC 606 certification, which clarifies the treatment of software costs. Previous guidance included this software license under internal use software guidance. For CCAs without a software license, they are considered service contracts (as defined as a SaaS above) and the fees are generally recorded as an operating expense.  Previous guidance did not address implementation costs for service contracts with no related software license. The recent update addresses any exceptions to expensing service contract fees which are dependent on the phase and nature of the specific service contract.

As we enter the holiday shopping season, could there be a more holiday-related accounting topic than accounting for gift cards? The gift card market has steadily increased annually as the vendor choices for cards and the methods of sending the cards have increased. Accounting for gift cards follows Financial Accounting Standards Board’s Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers.  This standard went into effect for many companies starting in 2018.

Recording the Sale 

When a gift card is sold to a customer, a sale is not recorded by the company; instead the sale is recorded as a liability because the company has an obligation to provide goods or services at a later date.  

Recording the Redemption

When a customer redeems a gift card, the liability account is reduced and gift card sales revenue is recorded.  This method of recording gift card sales is consistent with purchase and redemption methods followed prior to the implementation of ASC 606.  

Accounting for Unredeemed Gift Cards - Prior to ASC 606

Within its financial statements, a company must account for the dollar amount of gift cards that won’t be redeemed.  The industry term for the unredeemed gift card amount is breakage. Prior to ASC 606 there was diversity among companies in how breakage was calculated and recorded.  Creating uniformity in breakage calculations was key in the convergence of GAAP and IFRS.  

Prior to ASC 606, gift card breakage was recorded when a company considered the chance of redemption as remote.  Many companies used two years as the amount of time to have passed for a gift card’s redemption rate to be considered remote. Once the two years (or other time period as selected by company) of inactivity had passed, the unredeemed amount was recorded to breakage revenue.     

Accounting for Unredeemed Gift Cards - After ASC 606

ASC 606 provides companies with a new method for recording breakage as revenue and this method is called the proportionate method.  

According to the proportionate method, breakage revenue is recorded on a pro-rata basis in proportion to the amount of gift card redemptions.  Companies must determine their historical pattern of breakage to calculate the percentage of gift cards considered unredeemable. Going forward the company can estimate the amount of gift cards likely to be unredeemed as new cards are sold.  Having historical data is key to using the proportionate method.

With the proportionate method, there is an increased chance that breakage revenue will be recorded sooner than in previous years prior to applying ASC 606.  Companies have the option to retroactively apply the proportionate method of calculating breakage. There are two options for retroactive application: full retroactive application and modified retroactive application.  Full retroactive application requires the restatement of prior period financial statements. Modified retroactive application requires an adjustment to opening retained earnings initially and this application method is chosen by most companies. 

Learn more about ASC 606 through Illumeo courses;

1. Revenue Recognition (ASC Topic 606): Case Scenarios Part 1   

2. Revenue Recognition (ASC Topic 606): Case Scenarios Part 2