Accounting for Software as a Service (SaaS) Arrangements by Customers

✦ SaaS arrangements allow customers to access software hosted by a vendor over the internet without taking possession of the software itself.

✦ Under ASC 350-40, such arrangements are generally treated as service contracts, not capitalized software assets, unless certain criteria are met.

✦ Implementation and upfront setup costs may be capitalized or expensed depending on their nature and timing.

✦ Accurate classification impacts balance sheet treatment, expense recognition, and compliance with cloud computing accounting guidance.

1. Scope and Background

✦ SaaS is a form of cloud computing where a company uses software hosted remotely by a third party.

✦ Customers do not control or possess the underlying software code. Instead, they pay subscription fees for access.

✦ The guidance comes from ASC 350-40, specifically clarified by ASU 2018-15.

2. Capitalization Criteria

✦ SaaS contracts are typically service arrangements, not internal-use software acquisitions.

✦ However, implementation costs incurred during the application development phase may be capitalized if: • The customer has contracted a third party to configure or customize the cloud environment • The services relate to setup and are directly attributable to the SaaS

✦ Training, data conversion, and post-implementation costs are expensed.

3. Classification of Costs by Stage

Implementation Stage	Treatment
Preliminary project stage	Expense as incurred
Application development	Capitalize if directly related
Post-implementation	Expense (includes training, support)

✦ Similar to internal-use software guidance under ASC 350-40.

4. Capitalized Costs — Amortization

✦ Capitalized implementation costs should be: • Presented as a prepaid asset (not software) • Amortized over the term of the hosting arrangement, including renewal options likely to be exercised

✦ Amortization is recorded in the same line item as the related SaaS expense (e.g., “cloud computing expense”).

Example:• Implementation cost: $90,000• Contract term: 3 years→ Amortize $30,000 per year over the term

5. Expense Recognition — Ongoing Fees

✦ SaaS subscription fees paid for access to the platform are expensed as incurred.

✦ Fees may be structured monthly, annually, or up front—recognize expense over the usage period.

✦ Report under operating expenses (e.g., IT expense or general & administrative).

6. Balance Sheet and Income Statement Impact

✦ Capitalized setup costs appear as other assets or prepaid expenses, not intangible assets.

✦ Amortization reduces operating income, but improves short-term EBITDA compared to full expensing.

✦ No asset is recognized for the software itself, as it is not controlled or owned by the customer.

7. Disclosure Requirements

✦ Total amount of capitalized implementation costs✦ Amortization period and method✦ Expense classification✦ Description of SaaS arrangements if material

✦ No need to disclose software name or vendor, but material SaaS adoption may warrant MD&A discussion.

8. IFRS Comparison (IFRS does not have equivalent detailed guidance)

Aspect	US GAAP (ASC 350-40 / ASU 2018-15)	IFRS (IAS 38)
SaaS access fees	Expensed	Expensed
Capitalization of setup costs	Allowed if criteria are met	Rarely allowed
Ownership of software	Not required	Not required
Disclosure guidance	Explicit	Limited

9. Common Errors

✦ Capitalizing subscription fees or training costs✦ Using software capitalization rules without evaluating SaaS-specific criteria✦ Failing to amortize implementation costs consistently over contract term✦ Misclassifying amortization as depreciation or software expense instead of service-related cost