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Your cloud transformation: Key accounting considerations and their broader impact
Understanding your cloud arrangement
Business model change is being driven and facilitated by cloud-based technologies and other powerful software capabilities. The benefits of these cloud-based technologies are considerable. Moving data, applications and platforms to the cloud can create substantial operational and business benefits.
This significant uptick in the volume and velocity of digital transformation initiatives, as well as expected changes in the accounting and reporting requirements for software costs means that organizations must understand the business impact of their IT strategy, along with the resulting effects on accounting, financial reporting, tax, and forecasting.
Understanding the impact to financial metrics
When assessing the financial reporting impacts of software-related spend, the accounting determinations made can have varying impacts to key financial metrics. Also, when in the context of an M&A transaction, the impacts to deal value and related financial reporting implications associated with software spend are important to keep top of mind.
For instance, costs deemed capitalizable for internal-use software (that are not CCAs) are usually classified as PP&E or intangible assets on an organization's balance sheet, with potentially no impact on current assets or working capital. Comparatively, capitalizable CCA implementation costs may be classified as prepaid or other current assets and could potentially impact working capital calculations.
Similarly, income statement impacts can also vary based on the nature of what is being implemented within an organization. Capitalizable CCA implementation costs are often amortized as cash operating expenses (such as SG&A), thus having no positive impact (i.e., not an addback) to key financial reporting metrics such as EBITDA.
Comparatively, capitalized internal-use software costs often provide an EBITDA add-back opportunity; however, depending on how the organization defines its relevant KPIs and non-GAAP measures, capitalized types of cash outflows, such as those recognized for capitalized internal-use software, could reduce metrics such as free cash flow. Each organization should carefully consider its own reporting needs, performance measures and the potential reporting impact of digital investments to minimize surprises on the back end.
In light of new requirements from the FASB to further disaggregate of income statement expenses (DISE) for tabular disclosure in financial statement footnotes, organizations should also be assessing how they capture the data related to its amortization of all software costs to facilitate more granular levels of P&L reporting, as increasingly requested by investors, lenders, and other stakeholders.
M&A transaction considerations
Additionally, as companies pursue M&A transactions, business transformation through digital investment frequently serves as a critical lever for accelerating the realization of target returns on investment (ROI). It’s important to recognize that software cost capitalization strategies can have significant implications for both the valuation and the operational integration process in a deal.
- Buy-side
- Sell-side
- Post-close operations and reporting
Buy-side
- Impacts to EBITDA and other key financial metrics
- The extent to which software costs have been capitalized should be assessed to ensure appropriate valuation and alignment with long-term growth projections
Sell-side
- Appropriate capitalization can increase enterprise value and the asset base
- Overcapitalization can overstate near-term financial health and raise concerns about future impairments and cash flow generation
- Considerations should be given around how capitalization affects debt covenant calculations
Post-close operations and reporting
- Harmonization of accounting policies related to software costs is needed (e.g., useful lives, capitalization thresholds, tracking costs)
- Operational inefficiencies may surface post-deal causing remediation efforts that impact projected ROI and overall deal success
Applying the guidance to emerging technologies
While software accounting guidance provides a helpful framework for assessing how to treat software costs across a variety of technological scenarios, applying it in practice can be challenging.
Investments in emerging technologies, such as Generative AI, have brought unique complexities from an accounting and financial reporting perspective. Organizational leaders should champion cross-functional collaboration within their organization, particularly in the context of capitalizing costs related to software acquisition and development when exploring these emerging technologies.
As your organization looks to investment in new technologies, there are several factors you should consider when assessing the appropriate accounting and related financial reporting impacts.
How PwC can help
PwC is a trusted resource for helping organizations of all sizes navigate the accounting and financial reporting challenges of cloud migration or IT transformation, including through investments in emerging technologies.
Our Cloud Accounting Services specialists can assist with financial reporting questions regarding software costs capitalization, as well as support your organization’s assessment of broader business implications as you invest in the cloud, embrace automation and emerging tech (including AI), and adopt agile methodologies for software development.
Additionally, our teams of professionals across our broader spectrum of PwC services possess deep experience with analyzing the financial, tax, people, operational, and technological impacts of IT investment, including assisting you in implementation, adoption, and efforts to operationalize your accounting policies.
Our knowledge can help you:
- Anticipate accounting and controls requirements
- Understand capitalizable costs, capitalized asset useful lives and KPIs, including peer benchmarking
- Identify key data and system limitations affecting complex accounting
- Strengthen software development governance and cost monitoring frameworks
- Better align and support analyses for the tax impacts of IT development and transformation efforts, including R&D tax credit eligibility
- Assess and mitigate gaps between current practice and core accounting requirements
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