Issues with Revenue Recognition Within the Software Industry

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Issues With Revenue Recognition within the Software Industry The Isoft Example
Financial Controller-SoftWarehouse Ltd

This report has been prepared for the Board of Directors of SoftWarehouse Ltd for elucidation about the contentious issues that have given rise to the publication of the article concerning Isoft’s issues with revenue recognition. Finally, it will also assess whether or not these issues are likely to affect SoftWarehouse Ltd.

TABLE OF CONTENTS

Executive Summary:3
Introduction:5
Part 1- Examining the Isoft Ltd example:5
PART 2 - The issues faced by software companies in relation to revenue recognition:6
Part 3- Issues raised that may impact SoftWarehouse Ltd:7
Part 4 - Future changes in revenue recognition standard:8
Conclusion:9
Reference List:10

Executive Summary:
This report has been prepared for the Board of Directors of SoftWarehouse Ltd for elucidation about the contentious issues that have given rise to the publication of the article concerning Isoft’s issues with revenue recognition. Finally, it will also assess whether or not these issues are likely to affect SoftWarehouse Ltd.

In January 2006, Isoft, a Manchester based supplier of software applications for the healthcare sector, announced that its profit would be below market expectations due to a required change in its accounting policy for revenue recognition. Isoft was forced to reverse revenue of approximately £70m in 2005 and £55m in 2004 – when Deloitte found that Isoft was recognizing revenue sooner than it should have been.

The underlying principle of Isoft’s historic revenue recognition policy had been that the value of the product licenses was recognised at the time of delivery, while the value of support and servicers was recognised as they were performed. Moreover, the value of licences was identifiable and separable form the implementation and support services provided. This is not aligned with what the AASB Revenue states. Consequently, Isoft engaged in controversial accounting practices. The company recognised revenue at the start of long-term contracts instead of recognising revenue over the life of the contract. Isoft was recognising revenues from contracts even though actual payments for some projects were due over an extended period (for example: one project it recognized revenue even though actual payments were to be paid over a two-year period).

The accounting practice of recognising revenue in this method lead to an overstatement of its income, and therefore had the effect of misleading the stock market and Isoft’s overall credibility. After realigning its revenues to the current period (in 2006) to reflect a fair value of its performance, 40% was taken off its share values and the company was forced to lay off 10% of its staff.

Isoft adopted a new revenue recognition policy, which more appropriately reflects the changing nature of the business as the group is involved with more complex and long-term product supply projects. In the new policy, licence revenues will be recognised 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 increase visibility and predictability of earnings.

At SoftWarehouse Ltd, our contracts with our customers involve the sale of customised software as well as its implementation and maintenance services. We recognise revenue in accordance to AASB 118. The revenue therefore, is recognised over the length of the contract. Due to the fact that our selling prices include an identifiable amount for the subsequent 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 completion of the transaction at the end of the reporting period. Therefore, I am confident that we will not encounter similar issues, which were faced by Isoft....
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