Cloud-software can be of various types as:
- Software as a service (SaaS) – This arrangement is a software distribution model where applications are hosted by the service provider and the purchaser has access to the software through a network. The customer maintains all infrastructure and hardware.
- Platform as a service (PaaS) – This arrangement is a model where the cloud provider delivers both hardware and software tools needed for application development. The provider hosts the hardware and software such that the customer does not need to perform installation or purchase in-house hardware and software. This model does not replace the full infrastructure of the customer’s needs.
- Infrastructure as a service (IaaS) – This arrangement is a model where virtualized computing resources are provided over the internet. The third party provider hosts the hardware, software, servers, storage and other components on behalf of its users.
IFRS 15 deals with these matters from the providers point of view. However we can use the same principle to decide whether to capitalize or expense these costs.
Non-refundable upfront fees
In many transactions, customers may pay an upfront fee at contract inception, which may relate to the initiation, activation or set-up of a good to be used or a service to be provided in the future. Under IFRS 15, entities must evaluate whether non-refundable upfront fees relate to the transfer of a good or service. In addition, the existence of such fees may indicate that there are other implied elements in the contract, such as the option to renew a service at a discounted rate because the upfront fee would not be charged for the renewal period. In such situations, the identified promised goods and services would also include those implied items. Under IFRS 15, the non-refundable fee is allocated to the identified performance obligations in the contract (which may include some implied performance obligations) and it is recognised as revenue as the performance obligations are satisfied. By requiring allocation of the upfront fees to the future goods or services or renewal options, the adoption of IFRS 15 may result in a change in practice for some entities.
See the illustrative example below:
Cloud Co. enters into a contract with a customer for a licence of its software and a non-cancellable one-year subscription to access the licensed application (the cloud services). The contract amount for the software licence is an upfront, non-refundable fee of CU1 million. The fee for the cloud services is CU500,000 for one year. The customer has the right to renew the cloud services each year for CU500,000. Assume that Cloud Co. determines the software licence and cloud services are a single performance obligation. There are no other promised goods and services in the contract. Therefore, the upfront fee is not associated with the transfer of any other good or service to the customer. However, Cloud Co. determines there is an implied performance obligation. That is, the right to renew the cloud services each year for CU500,000 is a material right to the customer because that renewal rate is significantly below the rate the customer paid for the first year of service (CU1.5 million in total). Based on its experience, Cloud Co. determines that its average customer relationship is three years. As a result, Cloud Co. determines that the performance obligations in the contract include the right to a discounted annual contract renewal and that the customer is likely to exercise twice.
In the light of above, it is possible for the customer to capitalize the set-up fees. The period of amortization will depend on your judgement as to how long you are going to use it (say for instance 05 years).
