In a previous article, I noted that XaaS is taking over the world. This article will provide an overview of several accounting issues related to XaaS that impact FP&A. We will follow the story of the fictional Frances P. Able, FP&A, whose company wants to implement an enterprise performance management system (EPM). Five years ago, Frances might have purchased the software from a vendor through a perpetual licensing agreement plus several servers to host the software. Today, Frances is choosing a software-as-a-service implementation.
Disclaimer: The information in this article is based on general industry practices; you should seek guidance from your controller and/or auditor on these topics and technical implementation.
Capex vs. Opex
In the past, Frances may have put together a large business case to justify the entire project, including the hardware and software to be purchased. The purchased asset, in this case the servers, would have been budgeted through the capital expense (capex) budgeting process and depreciated over time; in a XaaS environment, they are now essentially rented and consumed as a service in the operating expense (opex) accounts. We will defer the treatment of the software costs to the next section. The table below explains the different treatments and impacts on FP&A analysis.
|Definition||An investment in an asset that will have a long-term (over one year) benefit for the company.||Cost that is used up in the running of a business.|
|Investment||Requires large outlay and is depreciated over time.||Impacts income statement and cash flow.|
|Balance sheet||Asset recorded on balance sheet.||None.|
|Cash flow||Impacts cash flow from investment||Impacts cash flow from operations.|
|Income Statement||Depreciation is recorded in operating income and net income; ignored in EBITDA.||Recorded as operating expense in EBITDA. A large shift from capex to opex will change financial metrics and ratios versus historical numbers, or versus benchmarks.|
|Impact on decision support||Intense review of the investment through the CapEx budgeting process, complete with business case and gated approvals.||It’s usually easier to get approval for a smaller monthly expense than a large, visible lump-sum payment. However, XaaS should get the same level of scrutiny! Think of the aggregate cost over three to five years.|
Perpetual License vs. As-a-Service Licensing
The treatment of Frances’ software has also changed. Previously, Frances would have bought and owned the software under a perpetual license agreement, which often is interpreted as buying an asset with a useful life that depreciates over time and may be considered capex. However, Frances also knows that some software may be considered an expense depending on the amount purchased and expected useful life. Frances will discuss this with the accounting team. In considering a SaaS product, Frances does not own the software, but only uses it and treats it as an expense.
|Topic||Perpetual License||SaaS License|
||If the two conditions for a perpetual license are not met, it is a services contract. The customer locally host a “thin client” on its own hardware, that is, a local interface or set of scripts that speaks to the robust backend hosted by the vendor.|
|Standard accounting||May be treated as a capital expense as above, or as an operating expense depending on factors such as amount, duration etc. Many caveats here; consult with accounting. Purchase generally includes seat licenses and annual maintenance costs; new releases and upgrades are additional. Upgrades may be expensed depending on circumstances.||Paid monthly, generally a number of seat licenses.|
|Set-up fees||Generally, various initial fees are bound with the service fees, and should be deferred and recognized over the life of the contract or the expected customer relationship.||Same as perpetual. Generally, if the contract is on month-to-month terms, the fees should be expensed when incurred. One category of caveats is whether the organization develops a proprietary application (asset) to work with service, for example, a front-end integration interfaces with Salesforce.com.|
|Training, other services||Expensed when incurred.||Expensed when incurred.|
Bryan Lapidus, FP&A, is a contributing consultant and author to the Association for Financial Professionals. Reach him at[email protected].
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