Some American companies see the shift to International Financial Reporting Standards as relatively harmless, figuring that they’re safe because they’ve been weaned on the stricter requirements of U.S. generally accepted accounting principles. But in some areas — especially among software companies with complex sales-contract structures — there’s still a need to be concerned, PricewaterhouseCoopers is cautioning.
“The biggest accounting challenge that we see for software companies is revenue recognition,” Dean Petracca, PwC’s global and U.S. software leader, tells CFO.com in an interview. And while software may be the area with the biggest headaches, “these problems are definitely portable to other industries,” he adds.
PwC recently prepared a study titled “A Shifting Software Revenue Recognition Landscape?” introduced by Petracca and European software leader Pierre Marty, in which they led off by noting the common assumption in corporate finance that conversion to IFRS will “simplify financial reporting and reduce the compliance burden for listed companies.” (It’s no longer proper to call it convergence, Petracca says. “It was once assumed that U.S. GAAP and IFRS would come together and be reconciled. Hence, the term convergence. Now the thinking is that U.S. GAAP goes away, and IFRS takes over.”)
The PwC study then laid out a case that the “economic and technical characteristics of the software industry make revenue recognition not only a thorny issue, but one of strategic importance for companies.” The principles-based approach of IFRS, with its “greater scope for judgment” allowed, may offer little comfort as a replacement to GAAP, with its “complex set of rules dedicated to the software industry,” the report said.
From Evaluation to “Close-down”
PwC, of course, is hardly alone in analyzing these issues. “All the Big Four firms are engaged,” Petracca says, “but we believe that we’re a few steps a head of some other firms when it comes to software. We’ve had a lot of experience helping companies in Europe and Australia, who’ve already made the conversion to IFRS.” That conversion involves three phases, he says, starting with a three-to-six-month evaluation, followed by 18 to 24 months of detailed work plotting out organizational changes that might have to occur, and a relatively short “close-down phase.”
Most companies in the software industry — where Petracca says PwC’s affiliations are very strong — are in the first review phase in preparation for IFRS. And there, they are learning that converting to IFRS can run far deeper into their organizations than they expected.
“Within the software industry, the effects of the changes may be exaggerated,” he says. “The requirements are that when you sell more than one product or service at one time, you have to break down the total sale value in individual pieces. Establishing the individual values under U.S. GAAP is solely a function of how the company prices those products and services over time.” Contracts typically include such multiple “deliverables” as hardware, software, professional services, maintenance, and support — all of which are valued and accounted for differently.