September 3, 2020

Clear Horizon for Cloud Software Capitalization

Jerry Cavalieri

Jerry Cavalieri

Managing Director, Regulatory Reporting

Ending years of varying interpretations and uncertainty, the Financial Accounting Standards Board (FASB) and the Federal Energy Regulatory Commission (FERC) have issued clear guidance on accounting for cloud-based Software-as-a-Service (SaaS) solutions.

Now, implementation costs related to SaaS service contracts may be capitalized in a similar fashion to more traditional installations of software purchased under a perpetual license agreement and run on-premises. The effective date is December 15, 2019.

Beginning in 2020, most public companies will be required to implement Accounting Standards Update 2018-15 related to ASC 350-40. This new standard indicates when to capitalize implementation costs related to a “Cloud Computing Arrangement,” or CCA for short. FASB defines a CCA as software obtained through a services contract, in contrast to software obtained through a traditional license that is treated as an asset.

CCAs for enterprise operations often require some amount of implementation work to integrate the SaaS with other core solutions, such as on-premises Enterprise Resource Planning (ERP) and Work Management solutions. Under the new accounting standards update, all of the implementation costs associated with a CCA may be capitalized.

That said, not every expenditure related to a SaaS offering qualifies as implementation, and, therefore, capital. Implementations are typically bookended by advance prep work and by training and post go-live maintenance and support. These front- and back-loaded costs are still considered expense. But the majority of spend in most CCA implementations is for configuration, coding and customization, and integration with other solutions, all of which is now allowed to be capitalized. Furthermore, SaaS contracts no longer need to include on-premises conversion clauses in order to qualify as capital expenditures, as was previously required.

But wait, there’s more—and it’s even better. In December of 2019, the chief accountant at the FERC aligned the rules for utilities filing under FERC jurisdiction to apply the same standard as the FASB. This decision provides clear guidelines on the correct FERC accounts to charge for CCAs. Capitalized cloud software costs shall be charged to FERC account 303 (Miscellaneous Intangible Plant). Amortization shall be accounted for in FERC account 404 (Amortization of Limited-Term Electric Plant) and account 404.4 (Amortization of Other Limited-Term Gas Plant).

Now that both FASB and FERC are aligned, what’s next for the state PUCs and PSCs? One possible future development will be to include CCAs in rate bases as regulatory assets, depending on how the service contracts are paid. For example, if a multi-year contract were paid in full upfront, then the CCA would be considered a prepaid asset and could possibly be allowed into the rate base. This is not yet certain in every jurisdiction. New York and Illinois have allowed treatment of CCA implementation costs as regulatory assets that can earn a return in the revenue requirement. At other state regulatory agencies, the treatment of CCAs with respect to rate base is still evolving.

The National Association of Regulatory Commissioners (NARUC) has issued guidance to allow recovery of a CCA as capital, indicating that “NARUC encourages state regulators to consider whether cloud computing and on-premise solutions should receive similar regulatory accounting treatment. Both would be eligible to earn a rate of return and would be paid for out of a utility’s capital budget.”

This new clarity for accounting for SaaS could not come at a better time. The global SaaS market is forecast to continue growing—for example, to $220B at a CAGR of 13.1% through 2022—and utilities are increasingly comfortable with SaaS offerings, if not actively seeking them out. Now that accounting regulations are no longer an impediment to adopting cloud software, utilities have an even greater opportunity to establish truly modern systems that wrap best-in-class SaaS offerings around their core SAP ERP.

At Utegration, we see the growing adoption of Cloud tenants to integrate with on-premises ERP apps like SAP. With the accounting treatment for CCAs now more clearly defined, utilities can embrace roadmaps that adopt these new, agile technologies to take advantage of the faster innovation cycles (e.g. quarterly tenant updates) that allow them to be more responsive to increasing customer demands and organizational changes in the utilities industry, knowing the implementation costs can be capitalized just like traditional licensed software.

If you’re ready to explore why more utilities are leaning toward cloud solutions now, check out our Utility4U platform, or contact us today.

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