The financial perspective of utilities’ cloud agreements

At this day and age, utilities are always striving to move at the same pace as technology. Because technology is evolving at a rapid pace, the adoption of new technologies requires that CFOs face several regulations related to accounting. Cloud computing is an example of this because it offers attractive services for utilities such as IaaS, PaaS, and SaaS but leaves businesses dealing with the hassle of how to capitalize on these investments.

Cloud services agreements have helped many utilities to dismiss difficulties such as high infrastructure costs and technological obsolescence. However, with these services, utility companies need to pay close attention to accounting changes as well.

Traditionally, utility companies would purchase on-premise software acquiring hardware and perpetual software licenses. In these cases, CFOs treated those investments as capital expenditure, meaning that they had the chance of increasing the rate that end-use customers paid to capitalize on these purchases. Conversely, cloud services imply a fundamental change in the accounting model, as utilities do not have to invest in hardware or software. Instead, they pay a recurrent subscription fee that is treated as an operational expense. With cloud services, utility companies do not own IT resources, so they cannot capitalize on these investments as they did with on-premise software.

The concerns about regulatory accounting for cloud services are growing rapidly, leaving us with one question: how can utilities capitalize their investments in cloud agreements?

On August 29, 2018, the Financial Accounting Standards Board (FASB) issued a new guidance for implementation, set-up, and other upfront costs incurred in a cloud computing arrangement (CCA). Precisely, PriceWaterhouseCoopers summarizes the vital aspects in the following business considerations:

1. IaaS and PaaS typically include a software license, since utilities rent the hardware and platform resources but still purchase the software. In this case, the utility company could capitalize on the software license agreements if it complies with two conditions. First, possessing the contractual right to take possession of the software at any time during the hosting period without significant penalty, and second, having the possibility to run the software either on its hardware or with another vendor(1).
2. As we mentioned before, SaaS subscription payments act as operating expenses. However, the new guidance clarifies that some implementation costs may qualify for capitalization, for example, third-party service fees to develop the software, the costs to obtain software from third-parties, and the coding and testing fees directly related to the software product. On the other side, some services generally are not capitalized, such as conversion activities, training, and software maintenance(2).

Although the Financial Accounting Standards Board established guidelines for cloud service agreements, utilities are governed by specific regulations depending on the state where they operate. Regarding the way utilities recover their investment from the cloud, the United States has different approaches for establishing a rate of return paid by end-users.

In fact, in May 2016, the New York Public Service Commission (PSC) issued a declaratory statement in its Reforming the Energy Vision (REV), in which utilities can earn on some types of REV-related operating investments(3). This way, the regulatory body endorsed an existing regulation and addressed a need that was concerning utilities.

In 2018, the Illinois Commerce Commission (ICC) proposed allowing utilities to pay for cloud services and obtain earnings from them as it would a typical asset. Although this is an evolution in regulatory accounting treatment for cloud computing solutions, the method employed by Illinois only provides a partial rate of return as compared to an on-premise solution(4).

This information gives you a more precise idea of the financial implications of cloud services, regarding accounting rules and rate-making mechanisms. Thus, it is up to each business to continue digging deeper into the context. It is vital to find a vendor that helps you capitalize on your cloud investments to achieve a seamless cloud adoption.

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