Here’s an update on the FASB’s project to revamp the rules for recognizing, measuring, presenting and disclosing software costs. The project is based on feedback from companies that find the current rules complex and costly.

Applying the existing guidance

There are two main areas of U.S. Generally Accepted Accounting Principles (GAAP) that provide accounting guidance for software costs. To determine how to account for software costs, a company first must evaluate which area of GAAP applies. The guidance that a company must follow is largely dependent on how a company plans to use the software.

Specifically, when a company determines that it has a substantive plan to sell, lease or otherwise market software externally (including licensing), it’s required to account for the software costs as external use. In this situation, Accounting Standards Codification Subtopic 985-20, Software — Costs of Software to Be Sold, Leased, or Marketed, would be applied.

Conversely, if a company doesn’t have such a substantive plan in place when software is under development, it’s required to account for the software costs incurred to develop or purchase software as internal use. In this situation Subtopic 350-40, Intangibles — Goodwill and Other — Internal-Use Software, would be applied.

The guidance for internal-use software is generally applied to hosting arrangements by both the vendor that’s incurring costs to develop the hosting arrangement for customers (such as software-as-a-service) and the customer incurring costs to implement the hosting arrangement. However, Subtopic 985-20 applies to hosting arrangements in which 1) a customer has a contractual right to take possession of the software at any time during the hosting period without significant penalty, and 2) it’s feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

Designing a one-size-fits-all approach

The ultimate goal of the FASB’s project on reporting software is to align the differing accounting models for external and internal use. If the project takes shape as planned, companies will no longer have to distinguish between two sets of guidance. Instead, they’ll apply a single model for all software. That means everyone would follow the same model, regardless of whether they purchased software as a license, entered into a cloud computing arrangement, or developed internal software, licenses or cloud solutions.

However, there’s little consensus now on how that model would work. Approaches currently being researched by FASB staff include:

• Requiring software costs to be capitalized based on a principle such as when there’s a present right to the economic benefit as a result of incurring the software costs,
• Requiring software costs to be capitalized if they’re undertaken during certain development activities, and
• Expensing all software costs, including cloud computing.

Members of the Private Company Council gave mixed views on which approach they favored, reflecting the difficulty the FASB could ultimately face on the topic. Some financial statement preparers prefer a principles-based approach, while others said they like the idea of expensing software costs as there’s no true prediction of its future useful life.

Stay tuned

This project is currently in the deliberation phase. No proposals have yet been issued, but the FASB plans to discuss this topic in the coming months.

A major issue that has surfaced relates to leases under common control. In a surprise move, the FASB voted on September 21 to propose changes to address stakeholder concerns.

Practical expedient for related-party leases

Topic 842 requires an organization to account for a lease that’s under common control on the basis of the legally enforceable provisions. Problems arose for private companies because some don’t have written documentation of related-party leases, and they’re confused about what’s “legally enforceable.”

FASB members unanimously agreed to propose a practical expedient for private entities to simplify the guidance for determining whether a lease exists for arrangements between entities under common control. A practical expedient is an accounting workaround with a simpler approach to arriving at the same answer as the initial rule.

The proposal specifies that entities would only consider the written terms and conditions when determining whether a lease exists, and the classification and accounting for that lease. Entities wouldn’t be required to determine whether those written terms and conditions are legally enforceable. Moreover, if no written terms and conditions exist, an entity would apply Topic 842 to any verbal or implicit terms and conditions. If no lease exists, other rules would apply.

Clarity on leasehold improvements

An affiliated issue that came up during the FASB’s review of Topic 842 is how to handle the treatment of leasehold improvements when there’s a verbal related-party transaction. In many cases, the life of the related-party lease could substantially differ from the actual life of the underlying lease asset.

The term “leasehold improvement” generally refers to changes, buildouts or upgrades to real property made by a commercial tenant. For example, you might paint, update lighting, install new carpet or make repairs to a space.

FASB members voted 4-3 to propose an amendment to Topic 842 that would specify that leasehold improvements associated with leases between entities under common control be “amortized by the lessee over the useful life of the improvements (regardless of the lease term) as long as the lessee continues to use the underlying asset.” If the lessee stops using the leased asset, it would then be “accounted for as a transfer between entities under common control.”

To be clear, if approved, this change would apply to both public and private entities. Public companies already implemented the updated standard in 2019.

It’s important to note that three FASB members dissented to proposing changes to leasehold improvement rules. The dissenters said that they didn’t have enough information to vote to propose changes for public companies and were uncertain about any secondary or indirect implications of the proposal. The members who were in favor of the proposal indicated that public companies would largely be unaffected by the changes. Their leases tend to be arm’s length, written agreements, regardless of whether the lessors are third parties or under common control.

Stay tuned

Since the updated lease guidance was issued in 2016, it has been deferred twice and amended five times. Once these two last-minute proposals are issued, there will be a 45-day comment period. In the meantime, private organizations must continue pushing forward with adopting the updated guidance for 2022. Contact us for help onboarding the changes, including any amendments for leases under common control.

Book minimum tax provision

A company’s book income as reported on its income statement may differ significantly from its taxable income for federal income tax purposes. The IRA — a $740 billion package with provisions on health care, climate and tax — will require companies that report over $1 billion in adjusted financial statement income (AFSI) to pay a 15% minimum tax rate on that income. Some of these companies may already be satisfying this requirement. But others with over $1 billion in book income, which may have taken certain credits or deductions that lower their tax rate below 15% of their AFSI, may be subject to additional tax liability under the new law.

Unlike previous calculations of corporate alternative minimum tax that started in taxable income, the minimum tax under the IRA starts with book income. In addition to allowing for the use of net operating losses and foreign tax credits, the calculation of AFSI allows exemptions for such items as general business credits and defined pension benefits. A late modification also allows for the reduction of AFSI by accelerated depreciation under the federal tax code.

FASB mission

The FASB develops U.S. Generally Accepted Accounting Principles (GAAP) for public and private companies and not-for-profit organizations in the United States. This rulemaking body is designed to be independent from influence by corporations and Congress. However, the book minimum tax rule could potentially give the FASB significant influence over some of the revenue the federal government collects — with potentially significant financial implications for U.S. companies.

This provision is effective for tax years beginning after December 31, 2022. It applies to any corporation (other than an S corporation, regulated investment company, or a real estate investment trust) that meets an average annual AFSI test for one or more earlier tax years that end after December 31, 2021. The Joint Committee on Taxation estimates that about 150 corporate taxpayers would be subject to this tax annually.

“Even though [the IRA] doesn’t directly involve FASB, it does have implications for FASB because it is asking major companies to pay a tax based on financial statement income which is based on GAAP standards set by FASB,” said Andrew Lautz, director of federal policy at National Taxpayers Union.

Changes made to financial accounting rules could have a direct impact on federal tax revenue. As a result, Congress may take more interest in the FASB’s work in the future and lobby for or against certain changes. Accounting standards could become targets for special interests and lobbyists. Any resulting rule changes could extend to all entities that follow GAAP, not just large corporations with more than $1 billion in AFSI.

Accounting industry pushback

“What is concerning at this point is that tying the new minimum tax to financial statement income creates incentives for companies to report lower book income, which may be at odds with the overall purpose of financial statements (and the goal of the FASB) to be a source of information that is useful to current and potential investors and creditors,” said Mary Cowx, Assistant Professor at the W. P. Carey School of Accountancy at Arizona State University.

The Financial Accounting Foundation (FAF), which governs the FASB, recently said tax and public policy matters are outside the FASB’s mission and should be left to Congress and other regulatory agencies. The FAF’s statement is consistent with a letter signed by more than 300 accounting professionals that was sent to Congress when it was considering the Build Back Better (BBB) bill. However, Congress made major changes to the book minimum tax provision from what was proposed under the BBB and what was signed into law under the IRA.

Stay tuned

It’s currently uncertain whether the new law will lead to unintended changes in GAAP. But the FAF is committed to maintaining the FASB’s independence and avoiding any adverse effects on investor confidence and capital markets. Contact us to discuss the status of current FASB projects that could affect income reporting, such as those related to bolstering income tax disclosures and disaggregating expense information on the income statement.

Today, many companies share research or technology to develop new products. For example, manufacturers might enter into a joint venture to conduct scientific research to design a new medical device. Or a watchdog group might work with a production company to create and distribute a documentary film.

How revenue and other payments between the parties are reported can have a major impact on a participant’s income statement. So, it’s important to get it right. Unfortunately, the accounting rules for so-called “collaborative arrangements” remain somewhat murky, despite updated guidance from the Financial Accounting Standards Board (FASB).

The basics

Companies set up collaborative arrangements largely to share costs. Accounting Standards Codification (ASC) Topic 808, Collaborative Arrangements, provides guidance for income statement presentation, classification and disclosures related to collaborative arrangements. It lists three requirements for collaborative arrangements:

1. They involve at least two parties (or participants),
2. All parties involved are active participants in the activity, and
3. All participants are exposed to significant risks and rewards dependent on the commercial success of the activity.

Topic 808 doesn’t provide comprehensive recognition or measurement guidance. Often, the accounting for these arrangements is based on an analogy to other accounting literature or an accounting policy election.

As companies began implementing Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), calls for clarity on collaborative arrangements increased. So, the FASB added this topic to its agenda in 2016.

Narrow-scope solution

In November 2018, the FASB issued an updated standard that went into effect in fiscal year 2020 for public companies and in fiscal year 2021 for private organizations. But the final version of the guidance was scaled back from what the FASB initially proposed. Items that didn’t make the final version of the updated guidance include:

1. Transactions with a collaborative arrangement participant that are directly related to third-party sales of either participant in the arrangement, and
2. Nonrevenue transactions between the participants.

Although the updated guidance doesn’t solve broader problems about the accounting for collaborative arrangements, it does address concerns related to revenue recognition. Specifically, ASU No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction Between Topic 808 and Topic 606, states that when a collaborative participant is a customer, the contract should be accounted for under Topic 606, including the recognition, measurement, presentation and disclosure requirements. But the parts of a collaborative arrangement that aren’t in the scope of the revenue recognition standard should be presented separately.

Lingering uncertainty

The FASB has acknowledged that questions will likely continue about the guidance for collaborative arrangements. If you’re uncertain how to report these transactions, we can help you determine whether transactions are covered by other accounting literature and, if not, develop a reasonable, consistent accounting policy for them. Contact us for more information.