Do You Own the Cloud?
By Rebecca J. James, CPA, Senior Manager and Elise Leslie, CPA, Senior Associate

Cloud computing arrangements are prevalent in business, and the insurance industry is no exception.  Is your organization in the cloud?  Have you questioned whether you are properly accounting for your cloud computing contracts?  The FASB recently issued guidance to clarify when these arrangements should be accounted for as software licenses versus service contracts.  

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Let’s consider an example.

You’ve entered into a 12 month contract for a cloud based policy administration system.  The vendor hosts the system on its hardware; you access the system via the internet.  (This is commonly referred to as a software as a service (SaaS) arrangement.) The contract calls for monthly payments of $14,000 with an option to purchase the software during the contract period for $500,000.  If purchased, the software continues to be hosted on the vendor’s hardware.  Now what?

To account for this arrangement as a software license, two criteria must be met:
1. You can contractually take the software during the contract period without incurring a significant penalty. A penalty can be a monetary cost or a decrease in the utility or value of the software.
2. You can host the software on your own hardware or can outsource the hosting to a third party.

In this example, the license fee seems fairly significant as compared to the annualized monthly fee.  Further, the hosting element of the contract is restricted to the vendor’s hardware.  Since neither criteria is met, this agreement would be accounted for as a service contract.  If the facts were changed and the software could be purchased for $200,000 and hosted on your hardware, or a third party of your choosing, both criteria would be met and the arrangement would be accounted for as a software license.

Cloud computing arrangements come in many shapes and forms.  Being aware of the nuances of your contract is crucial as you determine the proper accounting for your situation.  The new guidance is effective for annual and interim periods beginning after December 15, 2015 for public companies and annual periods beginning after December 31, 2015 for all others, so you have time to figure out the proper application.  Early application is permitted.

For more information, contact: Rebecca James at rjames@johnsonlambert.com or Elise Leslie at eleslie@johnsonlambert.com.

 
Pictured: Rebecca J. James (left), Elise Leslie (right)