Auditor: Convergence Could Spur Revenue Wreck

Will U.S. tech companies lose out if foreign issuers can use international accounting standards to report here?

The Securities and Exchange Commission’s proposal to stop requiring some foreign companies to reconcile their financials with U.S. generally accepted accounting principles has been touted as a way to keep those companies invested in the U.S. capital markets. By not having to pay for the reconciliation reports, the thinking goes, the companies that use international financial reporting standards will be encouraged to keep their financial stakes here.

The proposed change, however, could put U.S. companies at a competitive disadvantage, according to Jay Howell, a partner in the technology practice at audit firm BDO Seidman. In particular, IFRS and GAAP differ when it comes to a key metric for tech companies — revenue recognition. Under IFRS, a company can show revenue growth “faster than a company that uses U.S. GAAP,” Howell told CFO.com.

Howell attributes the discrepancy largely to the more principles-based nature of IFRS, which he says enables foreign companies to be more flexible about when they can recognize revenue. That’s especially important for emerging tech companies because customers, investors, and analysts see revenue recognition as the easiest way to grasp such a company’s worth, Howell says.

Since a company using IFRS can record revenue in an arrangement including more than one deliverable item sooner than a company using GAAP can for a very similar transaction, the IFRS user automatically looks better at first, Howell contends. Even though both companies could have the same product and similar financial health, customers could see them differently because of the U.S. GAAP-company’s delay in its ability to recognize revenue.

To describe his theory, Howell gives the following basic example. Say a U.S. cell phone company sells a customer a one-year service plan with a free phone but the service agreement falls through. The company would then be unable to record the revenue realized from the phone (which is paid for via the customer’s payment for the service contract).

In contrast, if the same company used IFRS it could estimate the phone’s fair value through the life of the service contract and record that revenue immediately. “Whether that’s better or not, I’m not sure,” Howell says. “There’s some validity to the fact that under IFRS you have delivered the phone and it does have value.”

G. Anthony Lopez, director of forensic and legal advising at FTI Consulting, says that although U.S. tech companies realize there’s a discrepancy, the only thing they can do about it is list on a foreign exchange. While he worked on staff at the office of the SEC’s chief accountant, tech companies looking to go public would ask when they could recognize revenue on a multiple element arrangement.

They were told that parts of that contract couldn’t be considered revenue for a few years. When accounting rulemakers reveal such a restriction to a Silicon Valley executive who knows that a foreign company could book revenue evenly over those years, “you know that the U.S. registrant is going to cry foul,” Lopez says.

To be sure, the International Accounting Standards Board and Financial Accounting Standards Board’s convergence project is meant to address some discrepancies between IFRS and U.S. GAAP. But observers say that isn’t likely to be completed by 2009, when the SEC’s proposed standard for eliminating the reconciliation requirement would go into effect.

On the other hand, they say, that SEC proposal will likely speed up attention for another idea thrown around by the commission as of late: whether to also allow U.S. companies to use IFRS. Currently in a discussion phase, the eventual decision by the SEC to do so is “fait accompli” as far as Lopez is concerned. If he’s right, the SEC would likely give companies at least three years to transition to IFRS, predicts Danita Ostling, a partner at Ernst & Young.

In the meantime, FASB and IASB haven’t made much progress on revenue recognition. “I don’t see the revenue recognition project resulting in a model anytime soon,” Lopez says.

Indeed, revenue recognition is one of the largest and most complex of the convergence projects before the two boards, according to Kenneth Bement, assistant project manager at FASB. He acknowledged that it would be hard to get the current standards to match and couldn’t predict by when that could be done. “With any convergence project, you have another board you are dealing with and more views to express differences,” he told CFO.com.

The good news, he contends, is that both boards’ revenue-recognition standards are consistent in principle. The problem is that U.S. GAAP is more prescriptive in this area. “International standards are not at the same level of detail,” he says. “There is more judgment involved.”

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