Among the many accounting standard updates and new standards that have been issued in recent years, there have been significant changes to the way organizations address service contracts.

The new lease accounting standards add complexity to how you address service contracts. On the other hand, Accounting Standard Update (ASU) 2015-05 simplifies accounting for cloud computing contracts, by providing clarity on an issue that has been a source of confusion for some time.

This blog will cover, at a high level, the new changes to accounting for service contracts and provide resources that you can use to learn more.

What to do when leases are embedded in service contracts

ASC 842 and IFRS 16 require that companies be more transparent about their lease obligations. To comply, companies need to thoroughly evaluate their service contracts to determine whether they contain embedded leases.

This additional complexity is time consuming. In a KPMG survey released earlier this year, respondents reported that identifying embedded leases was one of the top four most challenging aspects of implementing the new standards.

There are no shortcuts to identifying embedded leases. Additionally, you need to have a clear understanding of what constitutes a lease, since your contracts will rarely contain the terms “lease,” or “rent.”

To give some better clarity on how to evaluate contracts, let’s walk through an example.

Company A has a security services contract with ABC Security. ABC Security provides cameras, monitors, and keypads for Company A’s facilities. The contract states that Company A will have full usage of specific pieces of monitoring equipment. The contract lists each item, along with an identification number, that will be used for this contract.

Company A will have full control over the monitoring equipment, and will obtain substantially all of the economic benefits of the security equipment. The equipment portion of this contract meets all of the standards required for an embedded lease: there are identified assets, Company A has control of those assets, and Company A obtains substantially all of the economic benefits of the assets.

If you’re looking for a starting point, security, logistics, and warehousing contracts commonly contain embedded leases. LeaseQuery offers an embedded lease test that you can use to evaluate each of your contracts for embedded leases.

Embedded Lease Tool

Additionally, make sure to read our blog on embedded leases for more information.

Accounting for software leases and cloud computing contracts – what’s changed

In 2018, the FASB released new guidance on how companies should account for the implementation and upfront costs associated with cloud computing contracts. The standard update, (ASU) 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, provides clarity on how to address software-as-a-service contracts, which are becoming more common.

Under the new guidance, the definition of “hosting arrangement” has expanded to include any arrangement where the customer has access to or usage of the software but does not take possession of it.

In light of this expanded definition, companies will account for implementation costs related to cloud computing arrangements in the same way that they account for implementation costs related to internally hosted software.

Read PwC’c comprehensive guidance here.

See the full standard update from the FASB here.

Looking ahead

The changes to accounting for cloud computing arrangements should offer some relief for accountants. As more software is hosted in the cloud and offered as a service, these updates enable you to keep up with the way technology is evolving.

Addressing embedded leases on an ongoing basis will require more legwork. You will need to implement processes that allow you to evaluate new contracts to determine if they contain embedded leases.

One standard gets simplified, and a new standard makes things more complicated. The Boards give a little and they take a little.