Food for thought (for the future) >> Bottom Lines Are Shifting for
Software Industry
By JERRY ACKERMAN
c.1997 The Boston Globe
A silent time bomb awaits some software
companies.
It takes the form of new accounting standards
that kick in next month for the software industry,
setting out rules for posting revenues that could
cut some companies' revenues _ and perhaps earnings as well.
Known blandly as Statement of Position 97-2, the new rules being
adopted by the accounting industry supplant a six-year-old standard
that now lets companies book some revenues long before the goods
or services are delivered _ or even developed.
By one estimate, invoking the new standards could mean hundreds of
millions of dollars in short-term revenue setbacks for the fast-growing
software industry.
The arcane but significant rule change was prompted by the increasing
complexity of software products and sales. Many of today's deals
involve integrated systems that wrap databases, accounting tools and
graphics into complex packages. Contracts for their development,
installation and subsequent support services can stretch out many
years _ a far cry from when buying software was ''like buying a shirt
at Filene's,'' as one specialist put it.
At the same time, revenue recognition has long been a hot potato in
the software industry, whose fast growth, aggressiveness and
eagerness to please Wall Street investors have often led firms afoul of
fiscal niceties.
But today's long lead times and product complexity have provided
even more wiggle room for a software firm to inflate sales, according
to specialists. Under existing rules that some deem ambiguous, a
company, for instance, could post the total value of a multiyear
contract on the day it is signed.
''I don't use the word 'fraud,' but because there hasn't been
clarification'' on how existing rules should be interpreted, ''a company
could be either very conservative or very aggressive,'' says Jack
Acosta, chief financial officer and a senior vice president at Sybase
Inc. in Emeryville, Calif..
US Securities and Exchange Commission accountants who asked to
not be quoted, said that the 40-page document should assist in
enforcing SEC regulations.
The old rules were written in 1991, when software companies that
now sell complex ''packaged solutions'' were less prevalent.
The update was written by a task force assembled by the American
Institute of Certified Public Accountants. The panel included members
from the SEC and the Financial Accounting Standards Board. The
AICPA says that while FASB, the final arbiter of accounting rules, has
not yet adopted the changes, its participation implies support.
Elizabeth A. Fender, director of accounting at the AICPA, says the
old rules were vague about when revenues on multiyear contracts
should be recognized. The new ones make clear that component
parts, like software upgrades, must be ''unbundled'' and posted
separately wherever possible _ and that each part must be priced at a
fair market value at the time of delivery.
Many software companies say they have been preparing for the
changes since they were announced in outline form two years ago. ''If
you anticipate it, you can deal with it,'' says James Tholen, chief
financial officer at FTP Sotware Inc. in Andover.
Others, however, can expect a major impact as the changes force
them to spread out projected revenues to correspond to when the
products and services will actually be delivered.
One of the first to formally apply the new standards _ and to take a hit
on its financial statements _ was Ovid Technologies Inc. of New
York. Despite increasing sales and strong cash flow, the company
reported a 58 percent drop in third-quarter revenues from 1996.
Ovid's chief financial officer, Jeff Hoerle, emphasized that the plunge
resulted from ''simply a change in accounting principles.'' But the
company also said the new rules will depress reported revenues ''in
each of the next three quarters.''
David Elsbree, a partner at Deloitte & Touche LLP in Boston, says
shareholders in publicly held companies will feel an impact if Wall
Street analysts who issue quarterly earnings forecasts don't understand
what lies ahead. ''If a software company didn't meet analyst
expectations because of some new accounting pronouncements, there
might well be some reaction in the market,'' he says.
Accountants say that in most cases, any sales or earnings declines
resulting from the shift should be recovered when revenues that are
deferred today are recorded in the future. The AICPA estimates this
transition will last about a year.
But during that time, the hardest-hit companies could be those selling
packaged solutions, which can include customized software that is
licensed in combination with consulting services, training, product
support, and software upgrades.
The deals sometimes include promises of the next generation of
software, if-and-when-developed. The new rules will discourage this
controversial practice.
Steven D. Krohn, a partner at the Boston office of KPMG Peat
Marwick LLP, says the new rules should make clear that ''you may
not take 100 percent of the sale (when the contract closes) if things
remain that have not been delivered.''
Although the accounting industry plays down the fiscal irregularities
that have repeatedly hit the software industry, there is little doubt that
loose bookkeeping practices have been a problem. ''A lot of
(software) contracts are being written so as to create legal and
accounting gray areas,'' says Elliott Levy, an associate professor of
accountancy at Bentley College.
Indeed, companies such as Kurzweil Applied Intelligence Inc. and
Kendall Square Research Corp., both of Waltham, Mass. and both
now defunct, have become case studies in how not to keep books.
The latest to join this list, Informix Corp. of Menlo Park, Calif.,
recently admitted it had been inflating its numbers since January 1994
by recognizing sales of its database products before they reached end
users. The company, with new executives in place, last week said the
writedowns it must now take over that 3 1/2-year period amount to
$236 million. |
