Accounting & DisclosureUncategorized

Cloud Accounting May Require New Controls, Impact Covenants

By November 29, 2019January 2nd, 2020No Comments

Treasury executives whose companies are relying more and more on cloud services should confer with their accountants about new requirements that potentially could impact loan covenants as well as operational elements tangentially affecting treasury.

Companies are increasingly choosing treasury management systems (TMSs) and other applications via the cloud rather than installing the software in their own data centers. The Financial Accounting Standards Board’s (FASB) new accounting standard aims make the accounting between the two approaches more similar by requiring companies to defer and amortize cloud-related costs rather than expensing them right away, as they do under current accounting.

“For companies that have these [cloud] arrangements, they will have to defer certain of those implementation costs to future periods, and that could impact some covenants, whether free cash flow, EBITDA, and other metrics,” said Sean Torr, managing director of Deloitte Risk and Financial Advisory.

On the plus side, said Chris Chiriatti, audit managing director at Deloitte & Touche, some companies may have avoided software as a service (SaaS) solutions if there was a sizable initial investment because under current accounting they have to expense those costs immediately. “Now they can defer those costs, and it may open up opportunities to use the cloud,” he added.

Challenges. One of the more challenging aspects of addressing the new accounting, according to Mr. Torr, is that management must exercise judgment over the costs to be capitalized. In addition, internal controls will be required to ensure that the capitalized costs are amortized to the P&L over the appropriate term.

“Additional processes and controls may have to be put in place to correctly identify the costs that need to be capitalized under the new standard,” Mr. Chiriatti said. He added that since under existing accounting a lot of those costs were expensed as incurred, companies didn’t need processes to identify and scrutinize their activities.

New controls. Under the new standard, companies entering into cloud contracts frequently and those with decentralized organizational structures should consider whether internal controls are sufficient to handle all cloud arrangements. Additionally, organizations should consider internal controls to ensure management’s judgment is consistently applied and costs are being capitalized appropriately. If those judgments are being made in a decentralized fashion, “then the rigor of the control needs to be greater,” Mr. Torr said, adding that companies will also have to have controls around what information they disclose in financial statement footnotes.

Companies may already have frameworks in place to determine what gets capitalized or expensed if they’ve built solutions on premise. However, for companies that have aggressively pursued cloud solutions, the framework may have gathered dust and become outmoded. “So for those companies there might be additional work because they may not have the processes currently in place that they can leverage,” Mr. Chiriatti said.

Effective date. The accounting goes into effect Jan. 1, 2020, for any company currently deploying software to the cloud, buying cloud services or presently incurring cloud implementation costs. Companies can adopt the standard early for any quarters they have yet to issue financial statements for.

Lining up accounting practices. Mr. Chiriatti noted that from a functional standpoint today there’s little difference between a company using software in the cloud or in its own data center, and that was a major factor prompting the accounting standard-setters to conclude that the deferral model should be the same for both situations.

Jacob Bromsey

Author Jacob Bromsey

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