In Brief Companies continue to struggle with implementing FASB’s new revenue recognition standard, which becomes effective this year. One sector that may experience particular difficulty is the cloud computing industry, which relies upon several unique kinds of arrangements.

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On August 20, 2014, the Board issued a proposed Accounting Standards Update, Intangibles―Goodwill and Other―Internal-Use Software (Subtopic 350- 40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which proposed to add guidance to Subtopic 350-40 to help entities evaluate the accounting for fees. An overview of FASB Accounting Standards Codification Topic 350, Intangibles — Goodwill and Other. 350-40 Internal-Use Software. ASC 350-40 notes the following.

The authors discuss how the new revenue recognition framework will affect cloud computing arrangements and recommend how service providers and users can adjust their processes to comply with the new guidance. * * * Cloud computing arrangements, broadly defined, are hosting arrangements in which the user of a licensed software product does not take possession of the software, but instead accesses and uses the software over the Internet (or other dedicated connection) on either an as-needed basis or by subscription [Accounting Standards Update (ASU) 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, ]. The corporate shift toward such arrangements has created accounting challenges for both managers and public accountants. With FASB’s recent adoption of Accounting Standards Codification (ASC) Topic 606, “Revenue from Contracts with Customers,” cloud service providers will need to revisit, and in some cases revamp, their revenue recognition policies and practices. The impact of the new standard will bring about substantial changes in the revenue recognition policies and practices of cloud service providers, both in the public and private sectors. Public entities must comply with the new revenue recognition standard for the first interim period within annual reporting periods beginning after December 15, 2017; nonpublic entities have an additional year to comply.

Early adoption is available, and companies can choose to adopt using either a modified or full retrospective approach. Due to a lack of resources and infrastructure, many private company managers are relying on the additional time to learn from public companies’ implementation.

Stakeholders, including managers and accountants from both big and small firms, recognize that the revenue changes are more complex than originally anticipated. Furthermore, system implementations to automate changes that should have been completed in 2017 are being pushed into 2018 as preparers continue to seek answers to questions arising from complexities within the revenue recognition process.

These uncertainties create obstacles to adoption for public and private companies alike, and further guidance is necessary to overcome these hurdles in the implementation process. This article discusses, in detail, the accounting challenges faced by providers in implementing the new revenue recognition standard for cloud computing arrangements and the impact that the new standard is likely to have on the cloud computing industry. Preparers, managers, board members, and those just entering this industry should be ready for the challenges that the new revenue recognition rules will create. Users of financial information, such as investors and creditors, should also have a sound understanding of how the new revenue recognition standard could affect decision making. Prior Guidance for Cloud Computing Arrangements Cloud service providers must determine whether to account for internal use software in a hosting arrangement as the sale and purchase of a software license or as a service contract, or both. Generally, internal use software obtained through a hosting arrangement is accounted for as a software license if the user has the right to possess the software at any time during the hosting period without incurring a significant penalty and the user can either run the software on its own hardware or contract with a party unrelated to the provider to host the software (ASC 605-55-121). Under the prior revenue standard, software contracts that meet these criteria were accounted for under ASC Topic 985-605, “Revenue Recognition—Software.” Most cloud-based contracts, however, do not meet the above criteria and were accounted for as service contracts that fall under ASC Topic 605-25, “Revenue Recognition—Multiple Elements Arrangements,” and the SEC’s Staff Accounting Bulletin (SAB) 104.