Issues with Revenue Recognition Within the Software Industry

Issues With r level offue sweetener Recognition at heart the Software Industry The Isoft Example Financial Controller-SoftWarehouse Ltd This report has been prepared for the mature of Directors of SoftWarehouse Ltd for elucidation ab out the contentious issues that dedicate given rise to the offspring of the article concerning Isofts issues with receipts science. Finally, it pass on also assess whether or not these issues are likely to cloak SoftWarehouse Ltd. TABLE OF CONTENTS executive director analysis3 Introduction5 federal agency 1- Examining the Isoft Ltd example5 PART 2 The issues faced by software product companies in relation to tax tax income deferred payment6 Part 3- Issues elevated that may impact SoftWarehouse Ltd7 Part 4 future day changes in gross lore standard8 Conclusion9 Reference List10 Executive Summary This report has been prepared for the Board of Directors of SoftWarehouse Ltd for elucidation some the contentious issues that amaze given r ise to the publication of the article concerning Isofts issues with taxation recognition.Finally, it will also assess whether or not these issues are likely to affect SoftWarehouse Ltd. In January 2006, Isoft, a Manchester establish provider of software applications for the healthcare sector, proclaimed that its profit would be beneath mart expectations due to a requisite change in its accounting form _or_ system of goernment for receipts recognition. Isoft was forced to stop r eventideue of approximately ? 70m in 2005 and ? 55m in 2004 when Deloitte found that Isoft was recognizing taxation quite than it should have been.The underlying principle of Isofts historic receipts recognition policy had been that the measure out of the product licenses was prize at the time of delivery, man the value of shop and servicers was value as they were performed. More everyplace, the value of licences was identifiable and dissociable form the implementation and support serve pro vided. This is not aligned with what the AASB tax income states. Consequently, Isoft engaged in controersial accounting practices. The comp any take ind tax at the bring out of long-term contracts instead of recognising revenue all over the bread and butter of the contract.Isoft was recognising revenues from contracts even though actual payments for some projects were due over an elongated expiration (for example one project it recognized revenue even though actual payments were to be paid over a bi course of instructionly period). The accounting practice of recognising revenue in this method lead to an over recital of its income, and whence had the effect of misleading the stock market and Isofts overall credibility. After realigning its revenues to the contemporary period (in 2006) to reflect a fair value of its instruction execution, 40% was taken off its share values and the follow was forced to lay off 10% of its staff.Isoft adopted a natural revenue recognitio n policy, which more appropriately reflects the changing nature of the business as the group is involved with more complex and long-term product publish projects. In the new policy, licence revenues will be value over the same period as the implementation of revenues, which may range from a few months to a number of years from contract signature. This will improver visibility and predictability of earnings. At SoftWarehouse Ltd, our contracts with our customers involve the sale of customised software as come up as its implementation and maintenance work.We recognise revenue in consonance to AASB 118. The revenue therefore, is recognised over the aloofness of the contract. Due to the fact that our sell prices include an identifiable derive for the attendant services, that amount is deferred and recognised as revenue over the period during which the service is performed. We recognise revenue by reference to the stage of point of the transaction at the end of the coverage p eriod. Therefore, I am confident that we will not encounter interchangeable issues, which were faced by Isoft.However, due to the lack of guidance from the IFRS and generally accepted accounting principles standards on revenue recognition, it is foreseeable that translations could become misguided or unaligned with these standards in the future. The issues raised by Isoft elucidate the importance of arranging an accurate picture of its earnings. The vocalise project of the FASB and the IASB is trying to converge the two sets of standards and offer a sensation revenue recognition model that can be applied consistently to various proceeding which would overlay these issues of lack of guidance.Introduction In January 2006, Isoft Ltd, a Manchester based supplier of software applications for the healthcare sector, announced that its profit would be below market expectations due to a change in its accounting policy for revenue recognition, when it announced its results for the year ended April 2006. This situation is not grotesque within the software industry and reflects the issues that software companies face when it comes to accounting for revenues.As the mo exonerateary controller of SoftWarehouse Ltd, my goal is to clarify and explain the main issues faced by Isoft Ltd the consequences of those issues on the business and finally to determine if those practices could also impact the fiscal reporting within SoftWarehouse Ltd. Part 1- Examining the Isoft Ltd example The underlying principle of Isoft Ltds historic revenue recognition policy had been that the value of product licences was recognised at the time of delivery, while the value of support and services was recognised as they were performed (Isoft 2006).Moreover, under this policy, the value of licences was identifiable and separable from the implementation and support services provided (Isoft 2006). AASB 118- Revenue (AASB 2010), gives some guidance on how to recognise revenue When the selling pr ice of a product includes an identifiable amount for succeeding servicing, that amount is deferred and recognised as revenue over the period, which the service is performed. AASB (2010) illustrates that statement by giving an example which can be applied to Isoft Ltds situation When the selling price of a product includes an identifiable amount for subsequent services (for example, after sales support and product enhancement on the sale of software), that amount is deferred and recognised as revenue over the period during which the service is performed. The amount deferred is that which will cover the expected cost of the services under the agreement, together with a reasonable profit on those services. Therefore, it seems that Isoft Ltds traditional policy is satisfying under AASB 118- Revenue.Isoft Ltd had to change its revenue recognition after Deloitte had found that some revenues had been recognised earlier than they should have been (Stafford 2006), which lead to an oversta tement of its income and therefore had the effect of misleading the stock market (Griffiths and Bowers 2006), and thus affect Isofts credibility. When the company was obliged to realign its revenues to the current period in 2006 to reflect a fair value of its performance, its revenues got wiped out and it knocked 40% off its share values. The company also announced that at 10% of its staff would be laid off (Meyer 2006). at a lower place Isoft Ltds new revenue recognition policy, licence revenues will be recognised over the same period as implementation revenues, which may range from a few months to a number of years from contract signature, and over the fully duration of the contract in the case of managed services (Isoft Ltd 2006). The group tell that a change of accounting policy for revenue recognition is postulate to more appropriately reflect the changing nature of the business as the group is involved with more complex and long-term product offer projects (Isoft Ltd 2006) .Isoft Ltd also mentioned that its new revenue recognition policy would increase visibility and predictability of earnings (RNS 2006). PART 2 The issues faced by software companies in relation to revenue recognition Isoft Ltd was accused of being engaged in controversial accounting practices. The main issue with Isoft Ltds accounting practices is that it was recognising revenue sooner than it should have been. The company recognised revenue at the start of long-term contracts instead of recognising revenue over the life of the contract (Moulds 2006).Indeed, during the year 2004-2005, Isoft Ltd accounted in full for the revenue raised as part of long-term contracts at the time of receiving part prepayments. Analysts had found that Isoft Ltd, the main software supplier for the NHSs ? 6. 2bn IT project, was recognising revenues from contracts even though actual payments for projects were only due over two years time (Neveling 2006). For the year ending April 2004, Isoft Ltd recognised ? 30m of payments from Accenture and CSC who were implementing the NHSs technology overhaul (UK Parliament 2007).One of the main issues in accounting is about revenue recognition, especially in our IT industry. As KPMG (2009) stated, IFRS does not provide any specific guidance on revenue recognition for software think transactions. The IFRS standard and the Australian GAAP standard on revenue recognition lack guidance when a transaction involves both a well(p) and services related to that good (IASB 2008) which is often the case for software companies. The clog for software companies resides in the fact that due to this vagueness, it is hard to distinguish the revenue from the software and the revenue from the services offered.As Stafford (2006) mentioned, Isoft Ltd is not the first software company to have had issues with revenue recognition. Part 3- Issues raised that may impact SoftWarehouse Ltd At Softwarehouse Ltd, we are providing customised software to our customers in t he mining industry. Our contracts with our customers involve the sale of customised software as well as its implementation and maintenance services. We recognise revenue according to AASB 118, which we previously mentioned in detail in part 1.AASB (2010) adds an raise point for guidance fees from the development of customised software are recognised as revenue by reference to the stage of completion of the development, including completion of services provided for post delivery service support. The revenue is therefore, recognised over the length of the contract. Due to the fact that our selling prices include an identifiable amount for the subsequent services we deliver, that amount is deferred and recognised as revenue over the period during which the service is performed.We recognise revenue by reference to the stage of completion of the transaction at the end of the reporting period. We are confident that we will not encounter a similar situation than the one Isoft Ltd went th rough. However, I have to admit that the AASB is not giving clear guidance regarding revenue recognition, which leaves us with our own interpretation. Due to this lack of guidance, it could be foreseeable that our interpretation could become misguided or unaligned with the AASB. We should always be aware that even though our policy is acceptable under the Australian GAAP, it doesnt designate that we are protected from making mistakes.Indeed, Isoft Ltds traditional policy was acceptable under the Australian GAAP. However, as their contracts changed, Isoft Ltd did not update its policy, which led to misalignment. At Softwarehouse Ltd, we have to bear in mind that if the type of contracts or transactions that we offer change, then we will have to update our policy to accurately reflect our financial position. Ultimately, we must ensure that we do not recognise revenue too early and overstate our income. Part 4 Future changes in revenue recognition standardWe are still guardianship a close eye on the project regarding the new revenue recognition model the Contract- based revenue recognition model. This is a control stick project of the FASB and the IASB whose goal is to converge the two sets of standards (Henry & Holzmann 2009) and to offer wholeness revenue recognition model that can be applied consistently to various transactions (IASB 2008). If adopted the proposed standard will replace vivacious standards AASB 118- Revenue. The core principle of this model is that an entity would recognise revenue from contracts with customers when it transfers promised goods or services to the customer.The amount of revenue recognised would be the amount of consideration promised by the customer in exchange for the transferred goods or services (RSM Bird Cameron 2011). Under this new revenue recognition model, it is stated that the entity should recognise revenue when its net position in a contract with a customer increases as a result of satisfying a performance obl igation. An entity satisfies a performance obligation when it transfers goods and services to a customer. (IFRS 2008). The last exposure draft (IFRS 2011) indicates if a romised good or service is not distinct, an entity would combine that good or service with other promised goods or services until the entity identifies a bundle of goods or services that is distinct. Therefore, the entity would account for the bundle as a single performance obligation. The revenue for that performance obligation would then be recognised over time by selecting an appropriate measure of progress towards plump satisfaction of the performance obligation (IFRS 2011). Conclusion One of the main issues in accounting concerns revenue recognition, especially within the software/IT industry.The IFRS and the Australian GAAP standards on revenue recognition lack guidance when it comes to multiple cistron transactions. Due to this lack of guidance, it is foreseeable that interpretations could become misguided or unaligned with the IFRS or Australian GAAP standards. The issues raised by Isoft Ltd, elucidate the importance of recording an accurate picture of its earnings. Indeed, Isoft had to change its revenue recognition after it was undefendable that some revenues had been recognised earlier than they should have been, which lead to an overstatement of its income and therefore had the effect of misleading the stock market.The joint project of the FASB and the IASB is trying to address these issues of lack of guidance. Reference List Australian Accounting Standards Board 2010, AASB 118 Revenue. operable from www. aasb. gov. au. 20 March 2012. Griffiths, I & Bowers, S 2006, Revealed Isofts U-turn on accounts problems, The guardian 2 November. for sale from <www. guardian. co. uk>. 8 April 2012. Henry, E & Holzmann, OJ 2009, Contract-Based Revenue Recognition, The diary of Corporate Accounting & Finance, pp. 77-81. ready(prenominal) from Proquest 28 March 2011.House of C ommons, Committee of humanity Accounts 2007, Department of Health the national programme for IT in the NHS, The Stationary Office, London. outside(a) Accounting Standards Board 2008, Discussion Paper Preliminary views on revenue recognition in contracts with customers. Available from <www. ifrs. org>. 20 March 2012. IFRS 2011, Exposure draft revenue from contracts with customers. Available from <www. ifrs. org>. 5 April 2012. KPMG 2009, Impact of IFRS on the Information Technology and Business figure out Outsourcing Industries. Available from < https//www. in. kpmg. com/securedata/ifrs_Institute/Files/IFRS_IT. df>. 10 April 2012. Meyer, D 2006, NHS IT timescale questioned as Isoft CEO resigns, Zdnet 15 June. Available from <www. zdnet. co. uk>. 7 April 2012. Moulds, J 2006, Isoft directors and ex- auditors face questioning in new inquiry, The cable 26 October 2006. Available from <www. telegraph. co. uk>. 5 April 2012. Neveling, N 2006, Whats going on at Iso ft, Financial Director 31 August 2006. Available from <www. financialdirector. co. uk>. 7 April 2012. RNS 2006, Isoft Change in Accounting Policy. Available from <http//production. investis. com/isoft/rnsfilter/rnsitem? d=1149746579nRNSH2501E>. 5 April 2012. RSM Bird Cameron Chartered Accountants, 2011, Revenue Recognition- unsanded and Revised Proposal, Available from http//www. rsmi. com. au/rsbcwr/_assets/main/lib90034/111220_financial%20insight_revenue%20recognition%20web. pdf>. 28 March 2012. Stafford, P 2006, Revenue Recognition is Isofts Curse, Financial Times 9 August. Available from http//www. ft. com. 5 April 2012. Uk Parliament 2007, Memorandum submitted by Ian Griffiths and Simon Bowers. Available from <http//www. publications. parliament. uk/pa/cm200607/cmselect/cmpubacc/390/6062640. htm>. 8 April 2012.