SaaS makes financial accounting easier
It’s been so much talked and written about technical benefits of Cloud computing. I thought of looking at it from financial accounting point of view. Comparing the traditional IT expenses with Cloud computing expenses especially SaaS model, might give a different picture of the income statement. Before I go ahead and try putting forward my interpretation, want to make a disclaimer that I am no way finance or accounting expert, this is just a plain interpretation of what I understood. Comments and suggestions are most welcome.
I would like to explain my interpretation with an example. Let us consider a manufacturing organization with an imaginary name “OrgABC”, where it wanted to implement an ERP system for better process management. OrgABC invested $120000, in hardware and software to implement this new ERP system. For the simplicity let us assume OrgABC has some consistent income statement per annum like below.
|Cost of Goods Sold||$200000|
|IT Depreciation ||X|
|Net Profit Before Tax||$700000-X|
Above is the simplest version of any income statement which you would have seen so far. The idea is not discussing about the income statement but gauge the impact of traditional IT spending versus Cloud IT spending.
Now the important part, you could see I have kept IT Depreciation cost as X which is a variable and whole of my academic life I have tried to find out its valueJ, here also the question surfaces again. The value of X here can be calculated with a simple straight line method of depreciation.Depreciation Value p.a. = (Cost – Residual Value) / Useful Life in Years
For simplicity let us assume Residual Value of H/W and S/W as zero, which is close to the actual hence the new formula
Depreciation Value p.a. = Cost / Useful Life in Years
OrgABC accountants and IT people come to a conclusion that the useful life of the hardware and software of ERP system is 3 years and hence the depreciation value comes out to $40000 per annum which in turn makes Net Profit before tax as $640000. But you could argue why it has to be 3 years only it can be 4 years, which makes the depreciation value as $30K per annum and net profit before tax to $650000 which is around 1.5% improvement.
There are lots of cases of using this technique to play around the numbers and show it improved for some benefits where as the numbers are as it is. Accounting and IT team could decide to assume the useful life as 12 years and showing the profit before tax as $690K instead of previously calculated $640K. According to the accounting practices there is nothing illegal here, it is completely the assumptions and biases which we have to make to factor the capital investment using depreciation. Any other stake holder might question the depreciation value and the useful life of the assets which might create friction within the stakeholders.
So, what’s the deal with cloud computing and SaaS model? You might have guessed it. In the SaaS model, we as a customer do not invest anything upfront instead it is pay as you go model like a utility service. Suppose OrgABC plans to buy an ERP service as a SaaS model, they would get a bill generated every month/year for their usage and that’s what they have to pay and account for. No guess work which might have caused wrong impression about the income statements with depreciation in place. SaaS model investment makes the accounting much more transparent as compared to the traditional IT investment where organizations have to show the investment as depreciation. Do accountants think much when they have to account for a telephone or internet bill? Obviously not!! It is very simple and straight forward, so as the case with IT investment in SaaS model.There are plenty of benefits of SaaS model, transparent and easy accounting cannot be the only reason to go for SaaS model. But in case you are going to buy services as SaaS model, it would definitely make your accounting easier. SaaS model helps to make the accounting of the IT spending as simple as accounting for a telephone bill, making your accounts transparent, unquestionable and less judgmental.