Ernst & Young recently published a report which criticises the poor accounting practices amongst UK software firms. The report asserts that over 40% of UK listed software companies have, what they term, poor accounting practices. There have been a number of instances in this year, a year in which there was a continuous stream of profit warnings, where those profit warnings arise because of poor accounting practices.
The focus of the report's concerns lie in the question “when should revenue be recognised?”. Software sales are an integral part of a software development and implementation project. Inevitably, they stretch over months and sometimes years. When should revenue be recognised? The report states, somewhat glibly, that “companies should book revenues when they are 100% confident that any further commitments and liabilities are recorded.”
Unfortunately, the UK Accounting Profession has never been in the vanguard when it comes to innovation, or commenting on innovation, with financial accounting and reporting implications. It has not yet developed a comprehensive set of recommended accounting principles in this area.
The report observes that the USA has more developed, generally accepted accounting principles governing the recognition of software sales revenues – the so-called US GAAP Statements. These set principles for determining when software sales revenues should be recognised. There should be an evidential contract. There should be evidential behaviour of delivery and acceptance of the product. On the balance of probabilities the revenues will be collected. There is a fixed and determinable seller's fee.
While it is likely that the current environment will encourage listed companies to adopt more conservative accounting practices, it is interesting to speculate how the myriad of smaller, non-listed UK software companies handle revenue recognition from software sales. It is probably an equally confused and subjective picture. Unless their banker or auditors specifically take them to task over their accounting practices, optimism will doubtless prevail.