Accounting for Outsourcing Costs: Expense or Capitalize? | Sherpas in Blue Shirts

Posted On April 21, 2014

A question we often receive from CFOs in the U.S. is how to treat the costs associated with outsourcing.

In 2007, Everest Group wrote a well-researched white paper on this topic, citing U.S. Generally Accepted Accounting Principles (GAAP). While seemingly a long time ago, the conclusions in the paper are still very true today, with minor updates.

Following are our suggestions on accounting treatment for four key categories of outsourcing costs: (In addition, see how our Finance and Accounting research helps orgs optimize global F&A operations).

# Cost Category Advised Treatment*
1. Exit or restructuring costs: These are costs related to employee termination benefits, contract termination, employee relocation, and facilities consolidation. These may include, but are not limited to: costs incurred in selling or otherwise disposing of a part of the business; consolidating and/or closing selected sites; and relocating operations from one site to another. The key here is that the cost must be incremental to other costs incurred in the course of normal operations, or be associated with a contract that will either be terminated or completed. Expense: Outsourcing implementation costs almost always need to be included in results from continuing operations, but restructure costs can be disclosed on a line item basis within the income statement.
2. Asset impairments: These are costs related to asset retirement abandonment or sale (primarily related to the IT infrastructure); an asset becomes impaired when its carrying value exceeds its fair market value. This can also be classified as a restructure cost.Note: A sale of assets by a client to a service provider at a price above FMV does not eliminate the requirement to record an impairment. Expense: Should be included in the income statement in results from continuing operations.
3. Transition and transformation costs: These are costs related to assessment, process reengineering, solution design, workforce redesign, and parallel processing. These includes costs associated with the preparation and administration of the RFP process, current state assessment, recruiting, training, and internal-use software acquisition, development, and implementation.Note: A scenario in which the service provider initially incurs these costs and then either re-bills them to the buyer or bundles them with future service fees does not eliminate the requirement for the buyer to recognize an expense. Expense: Although transition and transformation costs are not recorded on a line item basis in the income statement, these costs need to be disclosed in the footnotes to the financial statements if they are material in amount.
4. Software implementation costs: These are costs strictly associated with the application development stage – acquisition license fees, configuration and integration, custom coding, installation to hardware, testing and parallel processing, and primary data conversion costs.Note: Most other software-related costs (implementation planning and evaluation, user training, and post-implementation operating) should be classified as transition or transformation costs, and must be expensed in the period they are incurred. Capitalize: Most of the costs associated with the application development stage may be capitalized.

 

As noted above, both exit and asset impairment costs should, in most instances, be disclosed in results from continuing operation, although they may qualify for disclosure as restructuring cost. However, if they are the results of an exit or disposal activity that involves a discontinued operation as defined in accounting standards codification section 205-20, they should be included within the results of discontinued operations.

For further information on the timing of expense recognition and the technical nature of the accounting treatments, readers should reference the following authoritative sources applicable in accounting standards codification section:

  • 205-20: Presentation of Financial Statements – Discounted Operations
  • 350-40: Intangibles–Goodwill and Other – Internal-use Software
  • 360-10: Property, Plant and Equipment
  • 420-10: Exit or Disposal Cost Obligations
  • 720-45: Other Expenses – Business and Technology Reengineering 

The U.S. Securities and Exchange Commission (SEC) recognizes the financial accounting and reporting standards of the Financial Accounting Standards Board (FASB) as “generally accepted” for purposes of the federal securities laws. The SEC is strongly committed to a single set of global standards, and recognizes that International Financial Reporting Standards (IFRS) is best-positioned to serve the role of that single set of global standards for the U.S. market and the ongoing convergence process between the FASB and the International Accounting Standards Board (IASB). The SEC does not permit its domestic issuers to use IFRSs in preparing their financial statements; rather, it requires them to use US GAAP. The SEC permits but does not require its foreign private issuers to use IFRSs as issued by the IASB in preparing the issuer’s financial statements.
* This guidance is based on Everest Group’s advice to its clients. In addition, the information is based on U.S. GAAP, and may not be in exact alignment with IFRS and IASB. Buyers should always consult with both their internal financial accounting staff and external auditors to determine how they should address the specifics of their situation.

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