Accounting for Software As A Service (SAAS) Costs

SAAS costs are covered by ASC 350-40 Internal-Use Software.

The requirements are clarified by ASU 2018-15.

Most startups make heavy use of Software As A Service (SAAS) applications to manage their operations. Software As A Service (also known as a Cloud Computing or Hosting Arrangement) is a software application that is owned and hosted by another party (the provider) and accessed remotely by the customer.

The customer, in this case, pays a license fee to access the software through a web browser. SAAS applications are popular, especially for startups, because they are easy to implement, easy to scale as the company grows, often cost less than traditional software, and updates are pushed out automatically. They don’t require large upfront investments or ongoing maintenance costs other than the initial implementation costs and ongoing license fees. And they don’t require teams of IT professionals to manage the infrastructure and servers that are required with traditional on-site software.

Software, in general, is divided into two broad categories, external use, and internal use.

1. External Use Software is to be sold, leased, or marketed to other parties and is covered by ASC 985 – Software
2. Internal Use Software is developed or obtained for a company’s own use and is covered by ASC 350 – Intangibles – Goodwill and Other

If you are using SAAS applications, they fall into the second category, Internal Use Software.

It’s also worth noting that Internal Use Software is outside the scope of Topic 842-Leases.

Payments to SAAS providers can be divided into three broad phases: the preliminary (pre-development) phase, the development phase, and the post-implementation phase. There are separate capitalization rules for each, where only costs during the development phase can be capitalized.

The old guidance differentiated between payments for an ongoing license vs a service fee. While the new guidance calls for the same treatment of both and differentiates among the project phases.

• Costs for software development to customize, develop, or modify the software, during the development phase should be capitalized.

Specifically, the accounting for SAAS applications is covered by ASC 350-40 Internal-Use Software and ASU 2018-15.

Ernst & Young has a good overview of the accounting requirements. And KPMG has one here.

The main idea is that the direct costs during the development phase associated with the SAAS application, including the ongoing license or service fees, should be capitalized. The other costs should be expensed as incurred, including any pre- or post-implementation costs.

The amortization period should include the term of the license agreement including any options to extend the agreement if the customer is reasonably certain to do so. As a startup, you may have a lot of uncertainty in your needs and deliberately not include any renewal options in agreements with SAAS providers. If that is the case, the term of the agreement may be limited to 1 year, and in fact, it could be less than one year from the time the implementation period ends until the end of the agreement. Consequently, in this scenario, it may not make sense to capitalize the implementation costs. You may also want to consider setting a minimum capitalization threshold based on materiality.

Disclaimer: your situation may be different. It is important you consult with an accounting expert regarding your specific situation.

This article was originally published February 11, 2019 and updated on November 10, 2021 and April 8, 2023.