The Hindu Business Line : Accounting for IT

Software acquired for sale in the course of trading is `inventory.' But what about software that comes embedded in hardware or software bought for use in the development of software? Read this `accounting dossier.'

THE total worldwide IT services spending is expected to grow from $535 billion in 2002 to $727 billion by 2007. This is a snatch of a Gartner report, cited by Ernst & Young (www.ey.com/india) in "IT EYe", a bulletin with `insights and perspectives on some of the complex accounting challenges faced by IT enterprises in India.'

Multiple element contracts

The `accounting dossier' begins with `a synopsis on accounting for software'. Software acquired for sale in the course of trading should be accounted for as inventory. But what do you do when software comes embedded in hardware? Answer: "Fixed asset if hardware element is significant; otherwise recorded as an intangible asset."

The treatment is different if software is bought `for use in the development of software'; you should then account for it as intangible asset, says E&Y.

At times, there can be a single contract known as `multiple element contract' to deliver `licences, implementation/customisation, and maintenance services'. Since Accounting Standard (AS) 9 on `revenue recognition' is silent on the topic, E&Y draws input from an opinion of the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI) in response to a poser of `a logistic service provider for container cargo'.

Though multiple element contracts are common in the IT industry, Indian GAAP (generally accepted accounting principles) and IFRS (International Financial Reporting Standards) do not offer help, rues E&Y's dossier. How do companies tackle this problem?

Here is an example from the accounts of Infosys: "Revenue from the sale of user licences for software applications is recognised on transfer of the title in the user licence, except in multiple element contracts, where revenue is recognised as per the percentage of completion method."

Of immediate value from E&Y's bulletin are queries and responses (though offered as `general guidance only'). Thus, you'd read about Debug Ltd licensing its product `Debugger' with implementation services and a one-year post customer support (PCS) term for Rs 12 lakh. If the fair values are Rs 9 lakh for the software, and Rs 3 lakh for implementation, and if "the user is entitled to all unspecified upgrades/enhancements, including those released during the free-maintenance period," what is the revenue that Debug Ltd should recognise from sale of licence?

Contracts, franchises and holidays

AS-7 on `construction contracts' is relevant not only for builders of bridges, dams, roads, tunnels, and complex equipment, but also for software developers associated with such projects. When Wipro states that `revenue on fixed price contracts is recognised in accordance with percentage of completion method of accounting' it refers to one of the methods that AS-7 mentions. "Progress can be measured under the percentage of completion method by using either input measures or output measures," notes E&Y.

Franchisee fee is like royalty payment, for the use of a brand. Franchising is a method adopted by computer training institutes. What will be your opinion if one such institute receives franchisee fee on a non-refundable basis and credits the amount to the profit and loss account? "Recognising entire fee upfront would be reasonable," opines E&Y, because such fee should be taken credit for "on a time proportion basis over the period of agreement".

We have been hearing much about barter transactions, in the form of oil for food, and cash for questions. The example in Laser Ltd query is an exchange of holiday for software.

For, Laser sold its ERP package to a travel agency, not for money, but in return for the agency agreeing to provide "low-price holiday' for 20 of Laser's employees. "There is no guidance under AS-9 on revenue recognition in case of barter transactions," laments E&Y.

It, therefore, uses guidance available in IAS-18 (International Accounting Standard), which states that revenue from barter transaction should be recognised only if there is an exchange of dissimilar goods or services; the value should be fair.

Software development, and incentive bonus

A simple visual in the dossier depicts three stages of software development, viz. preliminary project, cost accumulation, and post-implementation. The dossier provides examples from published accounts. For instance, Polaris Software Lab states, "Software product development costs are expensed as incurred until technological feasibility is established." And TCS says, "R&D expenditure is recognised in the profit and loss account when incurred. Fixed assets utilised for R&D are capitalised and depreciated."

The key issue, according to E&Y, is the time when technical feasibility is established. "There is no detailed guidance in this regard under Indian GAAP. However, the US GAAP, FAS 86 `Accounting for software to be sold, leased, or otherwise marketed' gives guidance on how to determine technical feasibility," informs the dossier.

The IT industry is known for imaginative compensation packages, which include performance bonus, profit sharing, ESOPs and so on. Look at the case of Computer Ltd, which has an informal practice of declaring bonus to its sales staff at the end of the year.

"Past evidence indicates that sales staff who meet their sales targets received a bonus of 10 per cent of their current salary package at the year-end.

However, in some years though targets were achieved, no bonuses were given and that too without any reason. Is a provision required to be made?"

In response, the dossier cites AS-15 and states that "in the absence of a formal policy and the discretionary nature of the bonus there is no legal obligation" and that no provision is needed, therefore.

Broken bonds and moving laptops

Read about ROM Ltd, which is in the ERP implementation business. All employees have to undergo training with an authorised training institute, and it seems the cost of instruction is Rs 2 lakh. Employees furnish `a bond of 2 years minimum service'. It seems ROM has successfully enforced the bond and recovered Rs 2 lakh from defaulting employees. "How should ROM account for training cost?"

The dossier offers its wisdom: "As per AS-26, usually an enterprise has insufficient control over the expected future economic benefit arising from a team of skilled staff and from training."

In the present case, as the management has legal control to obtain benefit for two years, it should capitalise the cost of training as an intangible asset and amortise it over the period, opines the firm.

The publication has chapters on share-based payment, income-tax, foreign exchange, contingencies, impairment and segment disclosures.

Before I put my pen down, let me narrate the problem of Pen Drive Ltd which has several segments but work is carried out in a common development centre. "Fixed assets like laptops are transferred from one operating segment to another operating segment on a need basis." The problem is not one of missing laptops, but of determining segment assets. `How should the laptops be allocated to the various segments?' IT EYe's view is that forced allocation on some arbitrary basis doesn't satisfy the criterion of reasonable allocation insisted upon by the Accounting Standard.

As with most matters on accounting and disclosure, there can be two or more opinions on the issues covered by the dossier. Yet, there can be no two opinions on its utility!

ITworks@TheHindu.co.in

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