Simplify Cloud Accounting to Deliver Perfect Harmony

We see the dissonance all the time. Organizations struggle to get their IT and accounting teams working together and IT’s desire to introduce cloud computing to the mix can often strike a flat note. Fortunately, harmony can be achieved in just three simple steps.

On its face, “moving to the cloud” seems like a simple enough term. Yet, as we will see, the term “cloud” carries a lot of meanings. Regulatory bodies tend to view the cloud as a remote data center. Information Technology (IT) infrastructure teams interpret it as a remote data center to host virtual machines. IT development teams see cloud as a collection of services. But the one topic that causes the most debate around cloud than any other is the accounting perspective. In IT’s world, cloud accounting is simply a capital expense (CapEx) moving to an operating expense (OpEx).

But the accountants’ point of view is that the cloud is a Cloud Computing Arrangement (CCA) which includes software-as-a-service (SaaS) and SaaS-type services or hosting – situations in which the end user does not take possession of the software; instead the software resides on the vendor’s or a third party’s hardware and the customer accesses it remotely. Fees paid in a cloud computing arrangement will be within the scope of the internal-use software guidance if both of the following criteria are met:

  • The company has the contractual right to take possession of the software at any time during the cloud computing arrangement period without significant penalty.
  • It is feasible for the company to run the software on its own hardware or a traditional hosted situation.

If a cloud computing arrangement does not meet both of these criteria, the arrangement is considered a service contract and separate accounting for a license under internal use software is not permitted. The service contract would be accounted for as a prepaid expense and amortized over the life of the contract. This often explains why IT thinks in simple CapEx v OpEx terms.

Before we dive deeper into the cloud, let’s inspect CapEx and the financial impact on a company. CapEx is purchasing an asset — in this case, two servers for $100,000 — and rather than taking the expense immediately, the company would capitalize the expense over time. Ideally, this would match with the life expectancy of the asset, usually three to five years. A depreciation table for the assets would be created, allocating $20,000 in expense over five years. For a public company, these expenses go to the balance sheet. Companies that prefer CapEx are looking to boost earnings and book value to attract investors.

On the other hand, OpEx would be taking the full asset expense in the year it was purchased. This goes to the income statement, which is used for taxation. Companies that prefer OpEx will often lease assets. These companies are generally trying to drive taxation down. Consideration of these basics will help understand motivations of the entire company.

Why does IT care? IT generally has a large spend footprint with variables to drive to CapEx or OpEx, giving accountants the ability to impact the accounting. Of course, IT wants to be good stewards of the company’s money. What if there was a way to let accountants do what accountants do best and IT do what IT does best?  What if IT could empower accounting to classify monies as they need to, based on corporate culture, company size, level of revenue and expenses, cash flow needs, seasonality and more? How much easier would IT be without having to consider the impact to accounting?  What does this have to do with the cloud?

Believe it or not, the cloud can make all of this possible. An alternate approach to IT is all it takes. IT should focus on three core common concepts: Cloud governance, enterprise project management and visibility for accountants.

We suggest starting with cloud governance, which is much easier to convert to cloud instead of retrofitting solutions. One very important piece to cloud governance is having a tagging strategy since all cloud resources can be tagged. A tag is simply characters and numbers associated with a resource for reporting. A resource, in this case, is any physical or virtual component of limited availability within a computer system. A tagging strategy to report resource spend is not only good for chargebacks, it can also provide the ability to proactively expose spend by resource.

Next, we look at enterprise project management (EPM), often part of a project management organization (PMO) that stands alone or reports into IT. Projects with a solid charter would include: the purpose in accounting terms, a solid governance of activities and project workers to record time on the activity, which can also be used by a good PMO for future forecasting.  All of these should be recorded in your EPM system.

Finally, granting accounting to the company’s EPM and tagging will allow accounting to be accountants.  Tags should tie to departments, while projects themselves or portions of these projects can be capitalized. This also allows projects in the cloud to be capitalized at the discretion of the accountant. As well, accounting now has solid documentation for the reasoning for capitalization or operational expense.

The Cloud is here. Most companies have moved at least some workload to the cloud with the promise of more advanced services with reduced expenditure. Those who employ sound governance and management functions and provide visibility for accounting, in turn provide the full flexibility to determine CapEx versus OpEx in order to optimize financials depending on the strategy of the company. These are the companies that are thriving in the world of the cloud. Welcome to the cloud!

Patrick Anderson

Managing Director
Technology Strategy and Architecture

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