Short term earnings in the US software industry are set to suffer if accountancy authorities carry out a threat to prevent companies declaring income from contracts before it has actually been earned.
The American Institute of Certified Public Accountants (AICPA)is set to tighten up legislation introduced in 1991, which was intended to prevent software companies from recording up-front revenues due to be accrued over the lifetime of a contract.
But the 1991 rules left companies considerable room for manoeuvre on when to recognise revenue generated from certain items, such as upgrades to software. For example, $20 of a $100 contract might be attributed to a software upgrade that will not be shipped for another six months. Existing legislation allows software companies to record all $100 of the contract value immediately.
If the proposed toughening up of the laws is accepted, then the upgrade could only be recorded on a company's balance sheet once it has been delivered. The new rules would also force software companies to assign "fair market values" to every element of a licensing sale or agreement.
The proposals will be reviewed early next year by the accountancy profession's rule-making body, the Financial Accounting Standards Board, and the Securities Exchange Commission, before becoming law, probably by the second quarter of 1997.
The SEC is known to welcome the AICPA proposals, feeling that the 1991 legislation is still open to abuse. But the new rules are likely to impact on short term earnings at some companies whose growth predictions will be exposed as overblown when they adjust their balance sheets to accommodate the changed legislation.
The proposed changes have won the backing of Microsoft, whose chief financial officer, Michael Brown, said the company was wary of getting ahead of itself in revenue recognition. At the end of its last fiscal year on 4 September, the PC software supplier had $651 million worth of defered revenue on its books, which it attributed to non-delivery of products to complete contracts.
A number of software companies were hit by the 1991 tightening of the accounting laws, prior to which there was little or no control over revenue recognition. Among the most famous casualties was database supplier Oracle, whose fall from grace in the early 1990s was followed by the revelation that its balance sheets were full of revenue from contracts that had not been completed.
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