Asset accounting under a hardware-as-a-service (HaaS) model
by Zachary Kimball on February 16, 2023
Hardware-as-a-service (HaaS) businesses manufacture or operate equipment that is offered on a subscription basis to customers. Examples of a HaaS solution include a fixed monthly service fee for a heavy asset (sometimes called EaaS), a robot offered on a pay-per-hour model (RaaS), or a suite of complex machinery that is billed annually (usually deployed by a systems integrator as a MaaS offering). These solutions usually include software, maintenance, and warranty programs as part of the offering.
In any case, the manufacturer or operator of the system should retain the equipment on their books as part of property, plant, and equipment (PP&E) and depreciate the equipment over its useful life.1 This is a different treatment than the classic equipment sales model, so it raises several important questions around (a) what to include in the equipment cost basis, (b) how to book the equipment during construction, and (c) when to transition the equipment to PP&E.
Some manufacturers will offer a hybrid “as-a-service” program where the equipment itself is sold outright and a separate software/solution package is offered for a recurring subscription fee. For the purposes of the following assessment, this is NOT a hardware-as-a-service business model where the manufacturer owns the equipment and leases it to the user as part of a subscription. Companies offering such a “hybrid” model should recognize hardware revenue (and cost) immediately upon sale, then deal with the recurring revenue according to typical non-equipment revenue recognition procedures.
|Disclaimer. This is not accounting, tax, or legal advice. We share our perspective based on work with finance teams across the hardware industry, but it is not intended to guide every case. For a deeper assessment of your own situation, get in touch and we can connect you with the right professionals.
What to include in the equipment capitalization (cost basis)
A HaaS business should capitalize the full costs of bringing the equipment to be fully ready for its intended use. This may include acquiring materials, direct labor, indirect labor, taxes, freight, installation, and interest. Not every piece of equipment will necessarily require all of these costs in order to be deployed. But when these costs are relevant, they should be included:
- Bill of materials (BOM) costs. These are the direct materials costs associated with the components of the finished equipment.
- Direct labor costs. These are the direct labor costs associated with assembling the finished equipment. This includes contract labor and services.
- Allocated indirect costs. These are the indirect costs that are not directly associated with the construction of the specific equipment, but are specifically attributable to the construction of a set of equipment and can thus be allocated across units. (e.g., includes shop floor managers fully dedicated to overseeing the equipment production line, but excludes the building manager who is also charged with facilities and security)
- Freight costs (in and out). These are the freight costs associated with getting component parts on site for production, and shipping out completed equipment to the site where it is fully ready for its intended use and location.
- Installation costs (on site). These are the costs of installing, setting up, or otherwise configuring the equipment at the proper location to bring it to a condition necessary for its intended use.
- Tax costs. These are the taxes associated with acquiring any of the other costs associated with making the equipment production ready.
- Interest costs. These are the financing costs associated with the capital required to produce the equipment and bring it to productive use. (e.g., includes pre-production supply-chain financing but does not include a post-production BOM loan)
This is a big and complex topic, varies based on the stage of development that the cost was incurred, and requires accounting judgment. For more information and examples, see the PwC summary of accounting for capital project costs.
Warning: For companies that offer hardware sales in addition to hardware subscriptions, there may be an instinct to book the subscribed equipment into fixed asset at the “typical” selling price (or MSRP) instead of the cost basis, and to expense the associated costs. This is incorrect! A piece of equipment sold on a subscription should move to long-term assets at its capitalized cost basis.
Where to book the equipment (accounts)
When equipment is in progress and destined for a HaaS model, the associated costs above should be loaded into a construction-in-progress (CIP) account, which is a non-current asset account.
In order to execute the HaaS model effectively, these numbers should be tracked at the asset level (i.e., by serial number). For construction tracking purpose, it is acceptable under accounting judgment rules to use approximations such as LIFO or FIFO if serial number tracking is not established until the equipment reaches a finished state. But once established, these approximations should then be tracked at the asset level going forward in order to monitor and understand the asset-level financial performance of the HaaS business model.
In some cases, hardware companies may have dual selling models, offering both a hardware subscription model AND a hardware sales model. In these cases, if it is possible to know in advance which pieces of equipment are destined for subscription, and which for sales, it is ideal to separate these across CIP and work-in-progress (WIP) accounts. More likely this separation will not be possible during assembly, so it is recommended to use a CIP account if subscriptions make up a meaningful majority of your equipment transactions, and a work in progress (WIP) account if sales make up even the slight majority of your equipment transactions. If in doubt, err on the side of WIP, which typically raises fewer questions because of its current-asset treatment compared to a longer-term CIP account.2
And in either case, but especially in the case of commingling assets for subscription and assets for sale in a single asset account, the more precisely you are able to track allocated costs at the asset level the better. This will be essential in order to ensure accuracy when comparing business models, as well as assuring auditors that you have effective controls in place for your commingled accounts.
When to move the equipment between accounts (timing)
Once equipment has been subscribed and brought to the condition and location necessary for its intended use, that asset should be added to the fixed-asset register and moved from CIP (or WIP) into a fixed-asset account. It is generally a good idea to set up a separate sub-account under fixed assets for each type of equipment being recorded.
This event generally happens at asset deployment, when the asset has been marked as fully ready for its intended subscription use. However, some costs may not be fully known at this time, such as the installation/setup costs of getting the asset ready on site. So in that event the asset would be entered later, once the full cost data is available. But the journal entry should be effective as of the asset’s deployment date.
For more details on the above topics, including both the accounting and tax treatments of assets for HaaS business models:
. . . the historical cost of acquiring an asset includes the costs necessarily incurred to bring it to the condition and location necessary for its intended use.
You place property in service when it is ready and available for a specific use, whether in a business activity, an income-producing activity, a tax-exempt activity, or a personal activity. Even if you are not using the property, it is in service when it is ready and available for its specific use.
If you purchase property to use in your business, your basis is usually its actual cost to you. If you construct, create, or otherwise produce property, you must capitalize the costs as your basis. In certain circumstances, you may be subject to the uniform capitalization rules.
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1. This does not consider alternative financing models, such as a sale-leaseback, which would change the accounting treatment for the manufacturer.
2. Because a CIP account typically receives treatment as a non-current asset, compared to a WIP account treatment as a current asset, CIP is more likely to attract attention from auditors.