Although the IFRIC agenda decision determined sufficient guidance already exists on this topic, it did clarify:
- the nature of expenditure that met the definition of an intangible asset
- the methods of differentiating between intangible assets and expenses, and
- the pattern in which the entity benefits from expenditure that does not qualify as an intangible asset.
Further detail on the application of the IFRIC’s guidance can be found within our ‘IFRS Viewpoint’ on Cloud computing arrangements.
Scope of the IFRIC’s agenda decision
Firstly, companies have found it challenging to identify which costs fall within the scope of the IFRIC’s agenda decision, because the process often involves understanding the nature of complex IT arrangements and linking the relevant costs. To be more efficient, some have taken a broad-brush approach and have applied the agenda decision across all its IT-related intangible assets. This is incorrect as the IFRIC made it clear that their decision was limited to C&C costs in a cloud computing or SaaS arrangement.
Error or change in accounting policy?
Secondly, while the IFRIC agenda decision did not create new accounting guidance, it is our view that its application would constitute a change in accounting policy as opposed to a restatement due to a prior period error (see the IFRS Viewpoint Cloud computing arrangements). This approach is consistent with what we’re seeing in practice as companies publish their interim and annual financial statements subsequent to issuing this agenda decision.
Similar to the implementation of other new accounting standards, the application of new guidance to existing balances or transactions can sometimes identify misapplication of accounting guidance in another area. Technically, the misapplication would constitute an error under IAS 8 ‘Accounting policies, changes in accounting estimates and errors’ and should not be combined with a change in accounting policy. However, as the disclosure requirements under IAS 8 for errors and changes in accounting policies are similar, we’re seeing both preparers and auditors approach this issue with materiality in mind.
Intangible asset vs expense
Thirdly, from a sample of randomly selected companies that were involved in cloud computing, we noted the reclassification of previously capitalised costs to administration expenditure resulted in a 3-30% reduction in intangible assets. This impact includes the reversal of any previous amortisation expense incurred against the capitalised cost. So those companies with more aggressive amortisation polices are seeing less of an impact from the accounting policy change.
While this agenda decision focuses on whether the C&C cost constitutes an intangible asset or an expense, we’ve noted some companies considering whether the C&C cost is a lease arrangement under IFRS 16 ‘Leases’. This is particularly relevant when the underlying cloud computing software is hosted and maintained on the supplier’s server. In this case, careful consideration should be given as to whether this change is treated as an error rather than a change in policy.
Insights into IFRS 16
Quantifying the impact
Finally, to understand the true impact of the agenda decision, many businesses have undertaken robust investigations to obtain, collate, and make judgements on the underlying information (for example, detailed IT implementation plans). Unfortunately, invoices relating to C&C costs are likely to be bundled together with other services making it difficult to identify ‘pure’ C&C costs that should be expensed. In many instances this is also the case with internal costs such as employee costs.
Businesses have also had to make significant judgements when quantifying the impact of the agenda decision. For example, limiting the analysis to costs which have not been fully amortised by the third balance sheet date. So they’re keeping their external auditor ‘front of mind’, knowing that they will require evidence to support all judgements made.
And last, but not least, remember all the judgements and assumptions applied in quantifying the impact of the agenda decision should be disclosed in the financial statements, in accordance with IAS 1 ‘Presentation of financial statements’.
If you would like to discuss this topic further then please let me know or speak to your local Grant Thornton member firm.