ASC 985-20: Cloud Computing Costs Capitalization Explained with Journal Entries

Posted In | ASC Education | Gridlex Academy

Accounting Standards Codification (ASC) Topic 985-20, Software – Costs of Software to Be Sold, Leased, or Marketed, provides guidance on the accounting treatment for the capitalization of software costs under Generally Accepted Accounting Principles (GAAP). In recent years, cloud computing arrangements have become more prevalent, and ASC 985-20 plays a crucial role in determining the appropriate accounting treatment for costs associated with these arrangements. This article will explore the key aspects of capitalizing software costs in cloud computing arrangements under ASC 985-20 and provide examples of journal entries to help you better understand the accounting treatment.
 

ASC 985-20 Overview

ASC 985-20 provides guidance on the capitalization of software costs for software intended to be sold, leased, or marketed, including cloud computing arrangements. The guidance applies to both internal-use software and software developed for external customers. The standard outlines criteria for capitalizing software costs and stages of software development, which include:

1. Preliminary project stage

2. Application development stage

3. Post-implementation and operation stage
 

Costs incurred during the application development stage can be capitalized, while costs incurred during the preliminary project stage and the post-implementation and operation stage are expensed as incurred.
 

Cloud Computing Arrangements

In a cloud computing arrangement, a customer contracts with a vendor to access and use software applications hosted by the vendor. Under ASC 985-20, if a cloud computing arrangement includes a software license, the customer should account for the license element in accordance with the software capitalization guidance. If the arrangement does not include a software license, the customer should account for the arrangement as a service contract and expense the fees over the contract term.
 

Journal Entries for Capitalization of Software Costs

To illustrate the accounting treatment for capitalizing software costs in a cloud computing arrangement, let's consider an example. Company A enters into a cloud computing arrangement with Vendor B, which includes a software license. Company A incurs $100,000 in implementation costs during the application development stage and $20,000 in training costs during the post-implementation and operation stage.
 

Here are the journal entries for Company A to record the software costs
 

1. Record capitalization of software costs during the application development stage:

Debit: Software Under Development $100,000
Credit: Cash $100,000

In this case, Company A capitalizes the $100,000 of implementation costs incurred during the application development stage.
 

2. Record the expense of costs during the post-implementation and operation stage:

Debit: Training Expense $20,000
Credit: Cash $20,000
 

Company A expenses the $20,000 in training costs incurred during the post-implementation and operation stage.

 

ASC 985-20 provides guidance on the capitalization of software costs in cloud computing arrangements, ensuring that the financial statements accurately reflect the costs associated with these arrangements. By understanding the accounting treatment and journal entries for capitalizing software costs in cloud computing arrangements, entities can maintain accurate financial records and comply with GAAP. Proper accounting for software costs in cloud computing arrangements is essential for demonstrating the financial impact of these arrangements on an entity's financial position and performance, providing transparency and comparability for investors and other stakeholders. Adherence to the provisions of ASC 985-20 ensures that financial statements accurately reflect the financial impact of cloud computing arrangements and the related software costs.