As the technology landscape continues to evolve at a rapid pace, accounting guidance for new technology is attempting to keep up. Remote work arrangements are becoming the norm, influencing entities to opt for cloud-based software subscriptions to accommodate for these changes. Existing Government Accounting Standards Board (GASB) standards have addressed software that is developed internally or purchased through perpetual licensing agreements; however, as cloud computing and other subscription-based software become increasingly popular, the guidance to account for these investments has been lacking. For example, if your entity selected a new cloud-based Enterprise Resource Planning software—a significant investment spanning across a subscription term of three years—how would that be reflected in the financial statements?
GASB Statement No. 96, Subscription-Based Information Technology Arrangements, defines a subscription-based information technology arrangement (SBITA) as a contract that conveys the control of the right to use a vendor’s software, alone or in combination with tangible capital assets (the underlying IT assets), as specified in the contract for a period in an exchange or exchange-like transaction. A SBITA can be for software as a service, infrastructure as a service, or a platform as a service arrangement. For an investment to be considered a SBITA, the government must have the right to obtain the present service capacity and the right to determine the nature and manner of use of the underlying IT asset. In other words, the government must have control over the asset.
Terms of a SBITA contract and the new corresponding standards are similar to a traditional lease; however, it is important to know when to apply GASB 87, Leases, or GASB 96. It is common for a tangible capital asset (for example, IT hardware) to be present in a contract; however, the software portion must be significant compared to the cost of the underlying capital asset to apply GASB 96. For example, a $500,000 server with a $1,000 software component may not be considered significant; however, a $500,000 server with a $100,000 software component would be considered significant. The organization should use their professional judgment to determine whether the software portion is significant to the contract, as a specific threshold has not been defined by GASB 96.
The subscription term begins when a government has a noncancelable right to use the underlying IT asset as well as periods covered by an option to extend (if it is reasonably certain that the government or SBITA vendor will exercise that option) or to terminate (if it is reasonably certain that the government or SBITA vendor will not exercise that option). For governments with a SBITA exceeding a 12-month term, the new standard requires the recognition of an intangible asset, a “right-to-use subscription asset,” and a corresponding subscription liability.
The value of this asset should be measured as the sum of (1) the initial subscription liability amount, (2) payments made to the SBITA vendor before commencement of the term, and (3) any capitalizable implementation costs, less any incentives received from the vendor at or before commencement of the subscription term. Costs are typically grouped in three stages:
- Preliminary Project Stage (determining the needed technology, evaluating alternatives, and vendor selection)
- Initial Implementation Stage (all ancillary charges necessary to place the subscription asset into service such as design, configuration, installation)
- Operation and Additional Information/Post-Implementation Stage (maintenance, troubleshooting, and other activities for ongoing access to the underlying IT asset).
Typically, outlays falling in the Preliminary Project and Post-Implementation stages are expensed as incurred while outlays in the Initial Implementation stage are capitalizable. As this is a general rule, each outlay should still be analyzed based on the nature of the activity, not the stage, to classify it properly. For example, training costs are always expensed as incurred, regardless of the stage. Essentially, if the additional costs result in an increase in the asset’s value (whether it be in functionality or level of service), it should be capitalized. It should also be noted that additional modules being placed into service after the initial measurement, if any, should be expensed.
Another component to the asset’s value is vendor incentives, which are subtracted from the initial value. Vendor incentives are common in software subscriptions or other IT contracts. This includes rebates (most common), reimbursements of end-user costs, or reductions of interest or principal charges. If these incentives occur after the subscription period begins, they should be factored into the present value of the subscription payments for the periods in which the incentives will be provided. Amortization of the intangible asset should be recognized as an outflow of resources (amortization expense) over the shorter of (1) the subscription term or (2) the useful life of the underlying IT asset.
Upon commencement of the subscription term, the liability recognized should equal the present value of subscription payments expected to be made during the term—whether they are fixed or variable. If payments that are dependent on usage are included in the contract terms, they are not included in the liability.
The future subscription payments should be discounted at one of two rates. The first option is the interest rate that the SBITA vendor is charging your entity, which may be implicit in the contract; if that rate is not readily determinable, the subscription payments should be discounted at the entity’s incremental borrowing rate. In subsequent financial reporting periods, the entity will recognize amortization of the discount on the subscription liability as an outflow of resources (i.e., interest expense). Only certain events in the future may trigger a remeasurement of the liability, such as a change in subscription term, estimated amount of payments, or a vendor change in interest rates. A change in the index rate would usually not be significant enough to trigger remeasurement.
Lastly, certain information is required to be disclosed in the notes to the financial statements under the new standard. For each SBITA, excluding short-term SBITAs, disclosures should include:
- A general description of existing SBITAs, such as the basis, terms, and conditions on which variable payments not included in the subscription liability’s measurement are determined
- The total amount of subscription assets and related accumulated amortization (disclosed separately from other capital assets)
- The amount of outflows of resources recognized in the reporting period for variable payments not previously included in the subscription liability’s measurement
- The amount of outflows of resources recognized in the reporting period for other payments, such as termination penalties, not previously included in the subscription liability’s measurement
- Principal and interest requirements to maturity, presented separately, for the subscription liability for each of the five subsequent fiscal years and in five-year increments thereafter
- Commitments under SBITAs before the commencement of the subscription term
- The components of any loss associated with impairment and any related change in the liability
GASB 96 is effective for fiscal years beginning after June 15, 2022, and all reporting periods thereafter; however, earlier application is encouraged. Assets and liabilities resulting from SBITAs should be recognized and measured using the facts and circumstances that existed at the beginning of the fiscal year in which this Statement is implemented. For example, if the standard is being implemented early for the fiscal year ending December 31, 2022, then the entity should be recognizing the related assets and liabilities that exist as of January 1, 2022.
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