Sierra On-Line Case
In 1992, Sierra On-Line was deep into the research and development of a variety of games for the competitive entertainment and educational software business. With a goal of going to market during the holiday season, they had a development schedule that had ballooned from six months to about a year. Sierra On-Line disclosed these development costs and timelines in their financial statements in a way that increased their revenues significantly year-over-year. In this highly competitive marketplace, this capitalization ‘fooled’ investors and analysts into thinking that Sierra On-Line was a stronger investment than in actuality and was not completely reflective of the economics of the industry. When developing new products, the software industry has to establish a point where products become technologically feasible for actual production. Once established, they forecast future sales and defer other costs. This action played a large role in deeming the future success for software companies; this was especially integral to Sierra On-Line because at least 40% of its sales were attributed to new titles. SFAS No. 86 defined the guidelines for establishing this point on a product-by-product basis and describing the cost shifts from a complete expense write-off to a capitalized cost based on the amortization of future revenues. Sierra On-Line used the selection of this point to its advantage in comparison to its competitors and in particular through King Quest VI and The Sierra Network (TSN). According to the Forbes article in the case, software companies capitalized about 20% of its R&D costs, but because of the highly competitive landscape and changing consumer tastes, most of Sierra’s direct competitors only capitalized around 10% of its costs. Newsworthy events show that TSN development costs had significant impact on the operating costs, and though they were still in the test stage, they had determined some revenue ideas based on early...
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