[Tech business & Tax Accounting] Cloud computing SaaS Business and Software Tax Accounting Treatment

[Tech business & Tax Accounting] Cloud computing SaaS Business and Software Tax Accounting Treatment

Disruptive innovation and Crossing the Chasm

Author Geoffrey Moore of ‘Crossing the Chasm’ argues that early adopters whom the people frothing at the mouth for the disruptive innovation are buy technology; while the majority buy products. A product is the technology plus everything else they need to actually make use of it, such as reasonable pricing and good support. The technology adoption lifecycle in ‘Crossing the Chasm’ of Geoffrey Moore explains that there is almost always a customer for the new technology, but making money means appealing to the mainstream. Crossing the Chasm is built around a model that every tech company needs to understand: the bell-shaped technology adoption life-cycle as illustrated below. The tech company should have itself to jump the chasm successfully and could achieve a Google, or Facebook size return on investment on the horizon.

Source: Crossing the Chasm, Author Geoffrey Moore

Crossing the Chasm and Cloud Computing

In terms of Crossing the Chasm of Cloud computing, Geoffrey Moore was saying “I am thinking specifically of enterprise IT here, and there is no question in this context that cloud itself has had to cross the chasm. But now that it has, and brought along with it SaaS applications and more recently mobile clients, the barrier to entry for next-generation B2B software companies is much lower. The chasm is still there, but it is nowhere near as daunting as it was a decade or more ago.” A great deal of tech experts argue that the essence of the fourth industrial revolution be Cloud computing and advise that a tech company should focus on the business to business (B2B) market based upon it.

Cloud Computing Software as a Service (SaaS)

Simply put, cloud computing is the delivery of computing services—servers, storage, databases, networking, software, analytics, diverse services, and more—over the Internet (“the cloud”). There are a lot of types of cloud services: Software as a Service (SaaS), Infrastructure as a Service (IaaS), Platform as a Service (PaaS), Big Data as a Service (DBaaS),Blockchain as a Service (BaaS), and maybe et cetera. Let’s more focus on Software as a Service (SaaS) over traditional software licensing as the following table at this time.

Software as a Service (SaaS) VS Traditional software licensing

Category	Software as a Service (SaaS)	Traditional software licensing
Software cost	Lower upfront cost	Up to three times the SaaS
Fee	Subscription	One time pay
Upgrade	All inclusive and managed by the SaaS provider	Additional pay and managed by the client
Maintenance cost	Zero and incurred by the SaaS provider	Variable between 25%~50% of the software cost and incurred by the client
Hosting cost	Zero and incurred by the SaaS provider	Server and maintenance costs and incurred by the client
Implementation cost	Low implementation costs	Costs typically 50% more of the software cost
Data back up	Managed by SaaS provider	Managed by the client
Personnel cost & requirement	Managed by SaaS provider	Managed by the client
Security	Managed by SaaS provider on behalf of clients with robust security requirements	Client manage data security, access, backup’s etc.
Infrastructure	A SaaS provider manages the servers and networks, and provides scalability and access, performance tuning and application management.	A client manages the infrastructure servers, networks, performance tuning, etc.

Software Accounting Treatment

Category	US-GAAP	IFRS
Software revenue recognition	Unlike IFRS, US GAAP provides specific guidance on revenue recognition for software and software-related deliverables in an arrangement. It applies to all agreement and contracts that are accounting for under “Ship and Bill”: contracts for sale of hardware, software, and services. Step 1: Persuasive evidence of an arrangement exists Step 2: Delivery of the software has occurred Step 3: The fee (contract fee) is fixed or determinable Step 4: Collection of the contract price is probable	IFRS does not provide specific guidance on revenue recognition for software-related transactions. The general revenue recognition requirements are applied to each component of the transaction. Step 1: Identify the contract Step 2: Identify performance obligations Step 3: Determine transaction price Step 4: Allocation transaction price Step 5: Recognize revenue
Multiple Element Arrangements	Must allocate the contract price to each element based on Vendor-Specific Objective Evidence (VSOE) of fair value and then recognize the allocated revenue when all revenue recognition criteria have been met on an element-by-element basis. Two approaches can be used to account for VSOE: Bell-shape curve approach and substantive renewal approach.	The concept of VSOE of fair value does not exist under IFRS. Although the price that is regularly charged by an entity when an item is sold separately is the best evidence of the item’s fair value, IFRS acknowledges that reasonable estimates of fair value (such as cost plus a reasonable margin) may, in certain circumstances, be acceptable alternatives.
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed	1. Research & Development (R&D) costs are expensed as incurred until the point of technological feasibility. 2. Software development costs must be capitalized at the point reaching the technological feasibility established when planning, designing, coding, and testing activities all have been completed until the point of the general availability. There are two methods of software capitalization: detailed program design and working model method. 3. Direct costs to reproduce and package the product, training materials and documentation manuals are capitalized as inventory at the point reaching general availability where product is ready to be released to customers. 4. Amortization begins once product is generally available. 5. [LCM] The unamortized capitalized costs of software must be compared to the Net Realizable Value(NRV) of the product to determine whether the product should be written off.	Under IFRS, Research costs are expensed, like US GAAP. However, unlike US GAAP, IFRS has broad-based guidance that requires companies to capitalize development expenditures when certain criteria are met: * Technological feasibility of completing the asset for use or sale has been achieved. * The entity intends to complete and use or sell the asset * The entity has the ability to use or sell the asset * The entity understands how the asset will generate probable future economic benefits. * Technical, financial, and other resources are available to complete development of the asset * The entity has the ability to reliably measure the expenditures. Under IFRS, there are no special requirements for software. The costs of such software are accounted for under the general principles for internally generated intangible assets or, in the case of purchased software following the general requirements for intangible assets.
Accounting for Costs of Computer Software Developed or Obtained for Internal Use	1. Preliminary project stage: expense 2. Application development stage: capitalize 3. Post-implementation / operation stage: expense 4. Amortization 5. Impairment test
Impairment test	Two steps test (recovery not allowed)	One step test (recovery allowed)
License fees and royalties	Like IFRS, to determine the appropriate pattern of revenue recognition for a license or royalty arrangement, the substance of the agreement is considered. Unlike IFRS, specific revenue recognition criteria may apply depending on intellectual property that is being licensed. The appropriate model depends on whether the license software requires significant production, modification or customization: 1. If none is required, then completed-performance model is used. 2. if it is required, the contract accounting is used, which generally requires application of the percentage of completion model.	To determine the appropriate pattern of revenue recognition for a license or royalty arrangement, the substance of the agreement is considered. The analysis of the substance of the transaction is based on the general principles for the recognition of revenue in the following circumstances: 1. The rights to the asset are assigned to licensee in return for fixed fee or non-refundable guarantee; 2. The contract is non-cancellable; 3. The licensee is able to exploit its rights to the asset freely; and 4. The licensor has no remining obligations to perform.
Cloud computing	Unlike IFRS, under US-GAAP, there are specific criteria for determining whether a cloud computing arrangement includes both a license of software and services or just service: 1. To the extent that the arrangement includes a license of software, the customer capitalizes the fee attributable to the license when the criteria for the capitalization of internal-use software are met. 2. To the extent that arrangement does not include a license of software, the customer accounts for the arrangement as a service contract and expenses the cost as the services are received.	Under IFRS, there is no specific guidance for cloud computing arrangements and the general principle for intangible assets apply

Comparison between USA and Korean Tax laws about Software Amortization

Category	USA (IRS)	Korea (NTS)
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed	1. Separately stated costs: The cost of software bought by itself, rather than being bundled into hardware costs, is treated as the cost of acquiring an intangible asset and must be capitalized. The capitalized software cost may be amortized over 36 months, beginning with the month the software is placed in service. 2. Bundled software costs: The cost of software included or bundled, without being separately stated, in the cost of the hardware is capitalized and depreciated as a part of the cost of the hardware. Under MACRS, computers are depreciable over 60 months using 200% declining balance depreciation method.	If externally purchased, 1. Direct revenue generation in usage: classified as an asset (tangible asset) by the type of the business on which the useful life in the table 6 of corporation income tax enforcement rules depends. 2. Others: classified as equipments and fixtures (tangible asset) on which the useful life in the table 5 of corporation income tax enforcement rules depends.
Accounting for Costs of Computer Software Developed or Obtained for Internal Use	A taxpayer may use any of the following three methods for costs paid or incurred in developing software for a particular project, either for the taxpayer’s own use, or to be held by the taxpayer for sale or lease to others: 1. The costs may be consistently treated as current expenses and deducted in full. 2. The costs may be consistently treated as capital expenses that are amortized ratably over 60 months from the date of completion of the software development. 3. The costs may be consistently treated as capital expenses and amortized ratably over 36 months from the date the software is placed in service.	If internally developed, 1. Direct revenue generation in usage: classified as a development cost (intangible asset) which is amortized over 20 years rately. 2. Others: classified as equipments and fixtures (tangible asset) on which the useful life in the table 5 of corporation income tax enforcement rules depends. 3. Not meet asset criteria: expenses immediately

50 Leading global SaaS companies for 2017

1) Salesforce	11) DocuSign	21) Xero	31) Eventbrite	41) GoodData
2) Microsoft	12) Cisco	22) Zuora	32) Paychex	42) SurveyMonkey
3) Adobe Creative Cloud	13) ServiceNow	23) AdRoll	33) New Relic	43) Cvent
4) Box	14) GoToMeeting	24) Xactly	34) Splunk	44) Blackbaud
5) Amazon Web Services SaaS	15) GitHub	25) Intuit	35) Domo	45)InsideSales.com
6) Google G Suite	16) Workday	26) Marketo	36) FreshBooks	46) ServiceMax
7) Slack	17) HubSpot	27) Bill.com	37) Tableau	47) Apptio
8) Zendesk	18) Twilio	28) Shopify	38) Druva	48) Veracode
9) ADP	19) Coupa Software	29) MuleSoft	39) Act-On Software	49) Anaplan
10) Oracle	20) Atlassian	30) Cornerstone	40) Blackboard	50) Rapid7

※ You can find your software at Capterra which is a free Web service that aims to help businesses find the right software solutions; https://www.capterra.com

Source: Geoffrey Moore’s ‘Crossing the Chasm’, IASB, FASB, PWC, KPMG, EY, Deloitte, McGraw-Hill Accounting Analysis, AICPA, KICPA, IRS, NTS, Becker, Datamation, Capterra

The tax information above is for your reference, and is not legally binding.