EL&F magazine article

“BLANK” as a Service:: The Starting Point from the Accounting Perspective

Tim Kolber and Steven Pinamonti

Setting the Stage

As technology evolves and business models adapt, many companies are shifting from the practice of owning, maintaining and managing their infrastructure to engaging a third-party service provider to perform these activities. This has created significant demand for as a service offerings.  

Whether the arrangement is marketed and sold as infrastructure as a service, lighting as a service, energy as a service or “fill in the blank” as a service, the general business model is similar. The as a service provider is engaged to take over and manage all aspects of a company’s infrastructure, including being responsible for evaluating, retrofitting, updating, maintaining and managing the related assets and technology. The company (or “customer”) will commonly still obtain all of the outputs from the infrastructure, but is freed from the responsibility of ownership, operation and maintenance.  Both the provider and the customer in the as a service arrangement need to evaluate how to account for these arrangements.

Accounting May Not Be Straightforward 

The starting point is evaluating whether the as a service arrangement is or contains a lease. Accounting Standards Codification Topic 842, Leases (“ASC 842”) explicitly defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for considerations.” ASC 842 provides a framework that includes three critical criteria that need to be in place to determine whether a contract is or contains a lease, with the most relevant questions to address being: 
• Does the customer have the right to use identified assets? 
• Does the customer have the right to substantially all of the economic benefits from using the assets? 
• Does the customer have the right to direct the use of the assets? 
 
Illustrative Example: Lighting as a Service  
Lighting as a service (LaaS) is an arrangement where the provider installs, upgrades, maintains and manages lighting systems and the related technology for a customer. The customer pays a monthly fee and shares the energy savings with the provider. The customer is generally subject to a subscription-based pricing structure and the arrangement eliminates the need for maintenance on lamps and fixtures. 

In evaluating the arrangement, it would likely be reasonable to conclude that there are multiple identified assets (e.g., lamps and fixtures) that will only be replaced for maintenance or upgrade purposes—so no substantive substitution right* exists. It would similarly be reasonable to conclude that the customer gets substantially all of the economic benefits from using the lamps and fixtures as it has the ability to use said assets to support its business needs. Even though the LaaS provider has the ability to maintain and manage the lighting systems, those decisions are likely not considered the most relevant how and for what purpose (HAFWP) decisions about how the assets are used. Rather it would likely be the customer that has the right to determine the HAFWP the lamps and fixtures will be used as it has the ability to decide when, whether and to what extent the lighting assets will be used throughout the period of use (e.g., will be able to initially determine and change the hours and days the lighting will be used to support its business).  

*A supplier’s right to substitute an asset is substantive only if both of the following conditions apply: (1) the supplier has the practical ability to substitute alternative assets throughout the period of use and (2) the supplier would benefit economically from the exercise of its right to substitute the asset. The supplier’s ability or right to substitute an asset for upgrade or maintenance purposes would not impact whether there is an identified asset.
In an as a service arrangement, there are generally multiple explicitly or implicitly identified assets that meet the ASC 842 “identified asset” criterion. Similarly, in an as a service arrangement, the customer generally has the right to substantially all of the economic benefits from using the assets as it has the unrestricted right to use the assets in question to support its business operations. The criterion that requires more judgment is assessing whether the customer has the ability to direct the use of the assets in this type of arrangement. This is generally reliant on the party that has the ability to determine how and for what purpose (HAFWP) the assets will be used throughout the period of use (i.e., has the ability to decide and change when and/or whether the assets will be used). It is important to remember that rights limited to operating or maintaining the assets—though  important to the efficient use of the assets—are not necessarily considered rights to direct HAFWP the assets are used. In an as a service agreement, there is a fine line between those decisions that are relevant to directing HAFWP the assets are used versus those that are not, and which are simply linked to operating and maintaining the assets.  


“The starting point is evaluating whether the as a service arrangement is or contains a lease.”   

 


In many of the as a service agreements, the customer will often be deemed to have the right to direct HAFWP the assets are used since, within the scope of its right of use defined in the contract, it has the ability to make relevant decisions about when, whether and to what extent the assets will be used to support its business. In contrast, the as a service provider’s rights are generally limited to operating and maintaining the assets.

The Bottom Line 

It is expected that as a service arrangement structures will continue to expand and evolve as technology improves and demand increases in the marketplace. Both the providers and the customers in these arrangements need to apply careful consideration and judgment when assessing the accounting implications, with the starting point whether the arrangement is deemed to be or contain a lease.  

In addition—and not the subject of this article—when the as a service arrangement is deemed to be a lease, providers and customers alike will need to evaluate the other accounting implications such as the pricing structure and lease classification as this may have a significant impact on how the transactions are accounted for from the balance sheet and income statement perspectives.  

Due to the complexity and judgment involved in these types of arrangements, entities are encouraged to consult with their accounting advisors where it makes sense.   

What You Can Do...   

If your company is offering or entering into as a service arrangements, it will be important to proactively establish a control structure that will allow for the proper evaluation of the arrangement in accordance with the accounting requirements. Some best practices include:  
• Developing an inventory of the available as a service offerings that may impact your company. 
• Establish internal policies and procedures to govern the review of these arrangements. 
• Educate and train key stakeholders about the lease identification accounting requirements. 
• Collaborate and communicate impacts across business functions. 
• Create a standardized contract review process that identifies whether a contract grants a customer the right to use an asset. 
• Document and disclose the position as required. 
• Regularly review, monitor and audit the process. 

By implementing a comprehensive control structure, a company can enhance its ability to identify embedded leases effectively and efficiently. This will result in improved financial reporting accuracy, compliance with accounting standards, and better business management of lease-related rights, obligations and risks as markets and industries continue to shift to as a service offerings.

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EL&F magazine article
LEASE ACCOUNTING
Financial Watch
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2023