Harvard Case - Dexus: Accounting for "Cloud Computing Arrangement"
"Dexus: Accounting for "Cloud Computing Arrangement"" Harvard business case study is written by Lilian Chan, Tsun-kan Wan. It deals with the challenges in the field of Accounting. The case study is 16 page(s) long and it was first published on : Jan 9, 2022
This case study analyzes Dexus's cloud computing arrangement and recommends a comprehensive accounting approach that aligns with Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), ensuring transparency and accuracy in financial reporting. This approach will involve a careful assessment of the arrangement's nature, the allocation of costs, and the recognition of assets and liabilities.
2. Background
Dexus, a leading Australian property group, is facing a dilemma regarding the accounting treatment of its new cloud computing arrangement. The company has entered into a multi-year agreement with a cloud service provider, utilizing a Software as a Service (SaaS) model. This arrangement involves significant upfront costs for hardware, software, and implementation, raising questions about the appropriate accounting treatment.
The key protagonists in this case are:
- Dexus Management: Seeking to understand the financial implications of the cloud computing arrangement and ensure compliance with accounting standards.
- Dexus Finance Team: Responsible for implementing the accounting policies and procedures for the arrangement.
- External Auditors: Responsible for reviewing and verifying the financial statements, including the accounting treatment of the cloud computing arrangement.
3. Analysis of the Case Study
This case study can be analyzed through the lens of Financial Accounting and Management Accounting.
Financial Accounting:
- GAAP and IFRS: The primary focus is on complying with the relevant accounting standards (GAAP and IFRS) for lease accounting and software capitalization.
- Asset Recognition: Determining whether the cloud computing arrangement constitutes a lease or a purchase, and accordingly, recognizing the relevant assets and liabilities on the balance sheet.
- Cost Allocation: Allocating the costs associated with the arrangement over the lease term or the useful life of the software, ensuring accurate income statement reporting.
- Depreciation: Identifying the appropriate depreciation method for the software and hardware assets, considering their useful life and the pattern of their benefits.
Management Accounting:
- Activity-Based Costing (ABC): Utilizing ABC to allocate costs associated with the cloud computing arrangement to specific business units or projects, providing a more accurate understanding of the cost drivers and profitability.
- Performance Indicators: Developing key performance indicators (KPIs) to track the efficiency and effectiveness of the cloud computing arrangement, such as cost per user, uptime, and performance metrics.
- Budgeting: Incorporating the cloud computing costs into the annual budget, ensuring adequate financial planning and resource allocation.
4. Recommendations
1. Comprehensive Assessment of the Arrangement:
- Conduct a detailed analysis of the cloud computing arrangement to determine its nature.
- Evaluate the control over the software and hardware, the transfer of risks and rewards, and the duration of the arrangement to determine whether it meets the criteria for a lease under GAAP and IFRS.
2. Accounting Treatment:
- If the arrangement is classified as a lease, follow the relevant lease accounting standards (ASC 842/IFRS 16).
- If the arrangement is classified as a purchase, capitalize the software and hardware assets and depreciate them over their useful life.
- Utilize a combination of lease accounting and software capitalization, if applicable, based on the specific components of the arrangement.
3. Cost Allocation and Recognition:
- Allocate the upfront costs associated with the arrangement over the lease term or the useful life of the software, using a systematic and rational method.
- Recognize the related expenses on the income statement over the relevant period.
4. Performance Monitoring:
- Develop and implement KPIs to track the performance of the cloud computing arrangement.
- Monitor the cost per user, uptime, and other key performance metrics to ensure the arrangement is delivering value.
5. Internal Controls:
- Establish robust internal controls to ensure the accuracy and reliability of the accounting for the cloud computing arrangement.
- Implement segregation of duties and regular reconciliation procedures to mitigate the risk of errors or fraud.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Compliance with Accounting Standards: The recommendations align with GAAP and IFRS, ensuring accurate and transparent financial reporting.
- Cost Allocation and Recognition: The recommendations ensure that the costs associated with the cloud computing arrangement are allocated and recognized appropriately, providing a true and fair view of the company's financial performance.
- Performance Monitoring: The recommendations promote the effective monitoring of the arrangement's performance, ensuring that it is delivering value and meeting the company's objectives.
- Internal Controls: The recommendations enhance internal controls, mitigating the risk of errors or fraud and ensuring the reliability of the accounting information.
6. Conclusion
By implementing these recommendations, Dexus can ensure that its cloud computing arrangement is accounted for in accordance with GAAP and IFRS, providing accurate and transparent financial reporting. This approach will also allow the company to effectively monitor the arrangement's performance and ensure that it is delivering value.
7. Discussion
Alternatives:
- Capitalizing all costs: This approach would result in higher initial asset values and lower expenses in the early years of the arrangement. However, it may not accurately reflect the pattern of benefits from the arrangement and could lead to a mismatch between expenses and revenue.
- Expensing all costs: This approach would result in lower asset values and higher expenses in the early years of the arrangement. However, it may not accurately reflect the long-term value of the arrangement and could lead to a misrepresentation of the company's financial performance.
Risks:
- Misinterpretation of accounting standards: The interpretation of accounting standards can be complex and subject to different interpretations. It is essential to consult with accounting professionals to ensure that the chosen accounting treatment is appropriate.
- Internal control weaknesses: Weak internal controls could lead to errors or fraud in the accounting for the cloud computing arrangement. It is essential to implement robust internal controls to mitigate this risk.
Key Assumptions:
- The cloud computing arrangement meets the criteria for a lease or a purchase under GAAP and IFRS.
- The company has a clear understanding of the costs associated with the arrangement and the pattern of benefits from the arrangement.
- The company has implemented robust internal controls to ensure the accuracy and reliability of the accounting information.
8. Next Steps
- Conduct a detailed assessment of the cloud computing arrangement.
- Develop a comprehensive accounting policy for the arrangement.
- Implement the necessary internal controls.
- Monitor the performance of the arrangement and make adjustments to the accounting treatment as necessary.
By taking these steps, Dexus can ensure that its cloud computing arrangement is accounted for accurately and transparently, providing a clear understanding of the financial implications of this strategic investment.
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Case Description
This case explores the accounting treatment for the costs attributable to cloud computing arrangements. The protagonist company is Dexus Diversified Fund (Dexus or the Group, ASX: DXS), one of the largest and most prominent real estate groups in Australia. In April 2021, the International Accounting Standards Board (IASB) ratified an agenda decision entitled Configuration and Customisation Costs in a Cloud Computing Arrangement. This decision governed the appropriate accounting treatment of cloud computing costs. This update on accounting treatment was added because of the global trend toward technology, data, and connectivity. It was more common for customers to not possess the underlying software. Rather, customers accessed and used the software on an as-needed basis. As the original IFRS did not contain explicit guidance on accounting for cloud computing costs, this update was aimed at clarifying this aspect. Dexus had deployed SaaS in its operations and incurred millions in cloud computing costs. Throughout its latest annual report as of 2021, the Group adopted the update in its accounting treatment and clearly disclosed the financial impacts. This case is developed for use in elementary, intermediate, and advanced accounting courses at bachelor, postgraduate, doctoral, and executive levels. The decision-making tree, accounting treatment, and financial implications for an entity to apply the update should be the key concepts to explore in the case. The issues on how to consider changes in accounting policies and in accounting estimates and errors are also explored in the case.
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