What is (and what isn’t) appropriate in terms of accounting for and recognising the revenue emanating from software-related contracts is a veritable minefield.
Alleged accounting irregularities formed part of the protracted Financial Conduct Authority (FCA) prosecution of the executive directors of iSOFT plc. The case against one of the founders of the company, Patrick Cryne, and three other directors - Stephen Graham, Timothy Whiston and John Whelan - was discontinued after their trial collapsed at Southwark Crown Court two years ago.
Since the early noughties there have been numerous instances of software companies, in the US and UK, falling foul of the complex and difficult area of when they can recognise revenue. This is because the nature and subject matter of software-related contracts means there is a fair degree of judgement and individual company practice involved.
These judgements and practices or errors of judgement and practice, be they innocent or otherwise, have caused these companies to have to re-state their previously reported accounts with the resulting damage to their reputation and credibility in the marketplace.
Having had the enviable experience of listening to not one but two experts for the prosecution in this specialised area in the iSOFT proceedings, it became clear to me that this isn’t an exact science. One accountant’s idea of what constitutes ‘persuasive evidence of an arrangement existing’ or when ‘physical delivery has occurred’ can be completely different to another.
For example the layman/jury member would probably think that satisfying the ‘delivery’ criteria in terms of a software product contract would be the simple receipt and installation of the disc by the purchaser. One of iSOFT’s auditors believed, however, that if software had been completely developed, was in its final form and was capable of being delivered the disc could, practically, still be sitting on a shelf in the supplier’s offices but, technically, ‘delivery’ would still have occurred.
The opinion of every qualified accountant, of which there were several, that gave evidence in the iSOFT proceedings was slightly or significantly different in respect of when revenue from software-related contracts could and should be recognised
Another spanner to throw in the works is the difference between the US and the UK accounting treatments in relation to software revenue recognition. Unlike the US, which under the US Generally Accepted Accountancy Principles (US GAAP) has SOP 97-2, the UK does not have a specific accountancy guidance and so, in general, UK software companies operate under the far less detailed terms of the International Financial Reporting Standards (IFRS) and International Accountant Standard (IAS), 18 from which the exercise of judgement as to what events trigger revenue recognition become more relevant.
A further complication in the iSOFT case, for instance, was that the auditors of the company had not performed their work to the required standard and did not obtain the sufficient audit evidence from iSOFT to satisfy themselves as to the appropriate accounting treatment in relation to the company’s major contracts.
This ultimately resulted in a hefty fine being imposed on that firm, and the audit partner individually, by the then Accountancy and Actuarial Discipline Board (AADB), now the Financial Reporting Council (FRC).
Ben Brocklehurst is an associate at Byrne & Partners