Issues with Revenue Recognition Within the Software Industry

Issues With tax tax income Recognition deep down the Software Industry The Isoft Example Financial Controller-SoftWarehouse Ltd This report has been prepared for the panel of Directors of SoftWarehouse Ltd for elucidation ab come out the contentious issues that fuddle given rise to the issuance of the article concerning Isofts issues with r crimsonue scholarship. Finally, it pull up stakes also assess whether or not these issues are likely to view SoftWarehouse Ltd. TABLE OF CONTENTS executive epitome3 Introduction5 dissipate 1- Examining the Isoft Ltd example5 PART 2 The issues faced by packet companies in relation to tax income acquaintance6 Part 3- Issues elevated that may impact SoftWarehouse Ltd7 Part 4 rising changes in taxation knowledge standard8 Conclusion9 Reference List10 Executive Summary This report has been prepared for the Board of Directors of SoftWarehouse Ltd for elucidation astir(predicate) the contentious issues that wee given rise to the publ ication of the article concerning Isofts issues with taxation recognition.Finally, it depart also assess whether or not these issues are likely to affect SoftWarehouse Ltd. In January 2006, Isoft, a Manchester establish supplier of software applications for the healthcare sector, inform that its profit would be at a lower place commercialize expectations due to a indispensable change in its explanation insurance for gross recognition. Isoft was labored to abandon tax income of approximately ? 70m in 2005 and ? 55m in 2004 when Deloitte found that Isoft was recognizing tax kind of than it should have been.The underlying principle of Isofts historic receipts recognition policy had been that the abide by of the product licenses was recognized at the time of delivery, mend the value of accompaniment and servingrs was get it on as they were performed. More everyplace, the value of licences was identifiable and severable form the implementation and support work pr ovided. This is not aligned with what the AASB R dismantleue states. Consequently, Isoft engaged in contr everyplacesial accounting practices. The comp all recognised taxation at the place of long contracts instead of recognising revenue over the support of the contract.Isoft was recognising revenues from contracts even though actual payments for some(a) projects were due over an extend head (for example one project it recognized revenue even though actual payments were to be paid over a bi stratumly period). The accounting practice of recognising revenue in this method lead to an enlargement of its income, and therefore had the doing of misleading the stock market and Isofts boilersuit credibility. After realigning its revenues to the contemporary period (in 2006) to reflect a fair value of its performance, 40% was taken off its share values and the participation was forced to lay off 10% of its staff.Isoft adopted a raw revenue recognition policy, which more appropr iately reflects the changing nature of the business as the group is involved with more complex and long-term product interpret projects. In the in the raw 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 profit profile and predictability of earnings. At SoftWarehouse Ltd, our contracts with our clients involve the sale of customised software as rise as its implementation and maintenance run.We recognise revenue in consent to AASB 118. The revenue therefore, is recognised over the aloofness of the contract. out-of-pocket to the fact that our interchange prices include an identifiable follow for the concomitant services, that kernel is deferred and recognised as revenue over the period during which the service is performed. We recognise revenue by reference to the stage of expiration of the transaction at the end of the report peri od. Therefore, I am confident that we will not encounter same issues, which were faced by Isoft.However, due to the omit of guidance from the IFRS and GAAP standards on revenue recognition, it is foreseeable that interlingual renditions could become misguided or unaligned with these standards in the future. The issues raised by Isoft elucidate the importance of recording an correct picture of its earnings. The voice project of the FASB and the IASB is trying to converge the two sets of standards and offer a integrity revenue recognition model that can be applied consistently to motley legal proceeding which would address 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 unknown within the software industry and reflects the issues that software companies face when it comes to accounting for revenues.As the pecuniary 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 price of a product includes an identifiable am ount for sequent servicing, that amount is deferred and recognised as revenue over the period, which the service is performed. AASB (2010) illustrates that disputation 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 sweetening 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 be of the services under the agreement, together with a reasonable profit on those services. Therefore, it seems that Isoft Ltds traditional policy is unexceptionable 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 overstatement of its income and therefore had t he 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).Under 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 dear duration of the contract in the case of managed services (Isoft Ltd 2006). The group stated that a change of accounting policy for revenue recognition is mandatory to more appropriately reflect the changing nature of the business as the group is involved with more complex and long-term product sum projects (Isoft Ltd 2006).Isoft Ltd also mentioned that its new revenue recogni tion 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 imp lementing 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 associate transactions. The IFRS standard and the Australian GAAP standard on revenue recognition lack guidance when a transaction involves both a safe and services related to that better (IASB 2008) which is often the case for software companies. The difficulty 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 the mining industry. Our contracts with our c ustomers 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 interest 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 through. However, I have to admit that the A ASB 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 home. 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 r evenue recognition model the Contract- based revenue recognition model. This is a enunciate project of the FASB and the IASB whose goal is to converge the two sets of standards (Henry & Holzmann 2009) and to offer single revenue recognition model that can be applied consistently to various transactions (IASB 2008). If adopted the proposed standard will replace existing standards AASB 118- Revenue. The karyon 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 duty. An entity satisfies a performance liability 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 complete gratification 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 element transactions. Due to this lack of guidance, it is foreseeable that interpretations could become misguided or unaligned with the IFRS or Australian GAAP standards. T he 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 exposed 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. gettable from www. aasb. gov. au. 20 run into 2012. Griffiths, I & Bowers, S 2006, Revealed Isofts U-turn on accounts problems, The Guardian 2 November. on hand(predicate) from . 8 April 2012. Henry, E & Holzmann, OJ 2009, Contract-Based Revenue Recognition, The Journal of Corporate Accounting & Finance, pp. 77-81. Available from Proquest 28 contact 2011.House of Commons, Committee of Public Accounts 2007, Department of Health the national course of stud y for IT in the NHS, The Stationary Office, London. International Accounting Standards Board 2008, Discussion opus Preliminary views on revenue recognition in contracts with customers. Available from . 20 shew 2012. IFRS 2011, Exposure draft revenue from contracts with customers. Available from . 5 April 2012. KPMG 2009, Impact of IFRS on the knowledge Technology and Business Process 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 . 7 April 2012. Moulds, J 2006, Isoft directors and ex- auditors face questioning in new inquiry, The Telegraph 26 October 2006. Available from . 5 April 2012. Neveling, N 2006, Whats going on at Isoft, Financial Director 31 sublime 2006. Available from . 7 April 2012. RNS 2006, Isoft Change in Accounting Policy. Available from . 5 April 2012. RSM Bird Cameron undertake Accountant s, 2011, Revenue Recognition- New 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 propagation 9 August. Available from http//www. ft. com. 5 April 2012. Uk Parliament 2007, Memorandum submitted by Ian Griffiths and Simon Bowers. Available from . 8 April 2012.