Why VSOE Spells Trouble

As software becomes more ubiquitous, many CFOs must now confront the nightmare of revenue recognition.

The Road Ahead

NEC, for its part, may still have to file restated earnings before it is free and clear of its U.S. legal obligations. Other companies deal with the constraints of SOP 97-2 by pointing investors toward metrics that show current business activity, such as billings and cash flow from operations. Secure Computing’s Steinkopf also shows revenues with VSOE adjustments, as if deferred revenue were considered current. But no one has a perfect solution. Most accept that their stock will trade at a discount because of the accounting, since “the vast majority of the market won’t do the work to get it,” says Glidden. Adds Piraino: “The auditing profession has made GAAP earnings meaningless to investors.”

Still, trying to make VSOE intelligible may be worth the effort. While many CFOs will shy away from an overly technical explanation in their earnings calls, Sondhi says he finds such an attitude condescending — and possibly telling. “It’s not rocket science,” he says. “When CFOs say this is too complicated, it usually means they don’t understand it either.”

Alix Stuart is a senior writer at CFO.

How to Cope with VSOE

  1. Keep careful records of the actual selling prices for products. Most experts say a price list is not enough to establish the vendor-specific objective evidence (VSOE) of a product’s worth required by SOP 97-2.
  2. Make sure the sales force is with you. Establishing VSOE precludes allowing salespeople to cut one-off deals or regularly offer customers special concessions. One way to solve the problem: Epicor Software told its salespeople they would not receive full credit for a sale unless the contract was written appropriately. Plus, “they get paid when we’re able to book the deal from an accounting perspective, so their commissions are in line with our accounting needs,” says CFO Michael Piraino.
  3. Consider establishing multiple VSOEs, if pricing varies significantly by size of customer or by geographic region. One firm, for example, uses different values for the same product, depending on whether it is sold in the United States or Asia, says Tony Sondhi, principal of financial advisory firm A.C. Sondhi and Associates.
  4. Don’t think you’re out of the woods just because you’re not in the software business. SOP 97-2 applies to any sale in which software is a “more than incidental” part.
  5. Be prepared to explain to analysts how SOP 97-2 is affecting the revenue stream, and when portions of deferred revenue will hit the bottom line. — A.S.

Notable VSOE Cases

  • REYNOLDS & REYNOLDS This automotive retail software and services firm announced in May 2006 that it would change the way it records revenues after a Securities and Exchange Commission investigation of its VSOE practices; it ended up going private through a merger later that year.
  • SMARTFORCE (NOW SKILLSOFT) The SEC began investigating the software company’s former finance officers, including CFO David C. Drummond, chief accounting officer John P. Hayes, and controller Patrick E. Murphy, after a 2003 restatement due to VSOE problems. In November the SEC ordered the three to pay a total of more than $2 million in ill-gotten proceeds from stock gains on the overblown revenues.
  • ASPEN TECHNOLOGY In July, the maker of supply-chain software settled with the SEC over allegations that it inflated revenues between 1999 and 2002, in part due to violations of SOP 97-2. Ex-CEO David McQuillin is serving a six-month home detention as a result of criminal charges. SEC fraud charges against McQuillin, former CFO Lisa Zappala, and former chairman Lawrence Evans still linger, as do shareholder lawsuits. — A.S.

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