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Making it all add up

Turns out that bean counting is part art, part science. Is there a method to the madness?

Tech Industry

Bean counting is part art, part science.

Ask the number crunchers at database maker Informix (IFMX), a company that has faced a wall of criticism from analysts regarding its methods for recognizing revenues in light of its unexpected $140.1 million first-quarter loss earlier this month.

Bean-counting methods are where the art comes in. Accountants must select a policy that will do the job and not alienate Wall Street or investors. From there, the number crunching is pure science.

High-tech companies' strategies run the gamut from aggressive to conservative. Analysts say that waiting until products reach end users before tallying up revenues constitutes a conservative strategy. Companies like Microsoft (MSFT), PeopleSoft (PSFT), and Oracle (ORCL), for example, follow this route.

Informix is more aggressive, counting revenues as soon as the products or licenses are sold to resellers or OEMs (original equipment manufacturers). Wall Street analysts say it's hard to gauge the real demand for a company's products if a lot of goods are sold into the distribution channel, which collects excess inventory.

Both bean-counting methods are acceptable under general accounting practices. Informix executives contend their company's practice is common in the software industry.

Roy Avondet, a partner with the Northern California technology group for accounting firm Deloitte & Touche, said that methods differ from sector to sector.

"There are some differences among sectors once you get past the general criteria," Avondet said. He added that the general criteria call for a product shipment to have taken place and the risk of ownership to be transferred from the company to the reseller, OEM, organization, or individual making the purchase.

"Semiconductor companies have been concerned about hot markets because their distributors will tend to order from multiple manufacturers in the hope of getting enough product," Avondet noted. "A lot of manufacturers are concerned about channel stuffing and won't recognize the revenue until it's been sold to the end user."

Intel (INTC), for example, defers income on shipments to distributors because it allows resellers to return unsold merchandise or guarantees price protection when the chip giant launches a price cut. The company, instead, counts sales once the merchandise is sold by its distributors.

Cyrix (CYRX), like Informix, counts its revenues once it ships products to distributors or OEMs. But the company also reduces a portion of those revenues based on estimates of product returns, uncollectable accounts, and price protections.

Computer makers count their revenues once they ship the products to resellers and OEMs too, according to Avondet. Compaq (CPQ), Apple (AAPL), and Hewlett-Packard (HWP), for example, all count their revenues at the time the products are shipped to their channels, but provisions are set aside to guard against product returns and price protection programs.

However, computer companies often have a different policy when it comes to selling products internationally, Avondet says. "They're more conservative and will wait to recognize the revenue once it goes to the end user."

He added that selling overseas usually poses a risk of receiving payment from the distributor during a 60- to 90-day period.

Software companies are a mixed bag. "They're much more conservative than they've been in the past, but that's because accounting requirements were tightened up in 1991," Avondet explained. The revised requirements demanded that software be delivered before revenue could be recognized, rather than allowing only a contract for delivery to be signed.

Another revision to the requirements is in the wind. The draft is currently in the "public comment" stage and a final version may be written by the end of the year.

"There is a wide disparity in the way that software companies recognize revenues," Avondet said. "It's from the way this industry developed so quickly...There are new ways of doing business that were never thought of before, like downloading software."

Under the proposal to revise the American Institute of Certified Public Accountants' Software Revenue Recognition requirements, or SOP 91-1, software companies would have to separately price the licensing, maintenance, customer support, and consulting services sold.

Microsoft, for example, does not recognize all its revenues at the time it ships products. The company lists the total revenue that hasn't been recognized on its balance sheet--giving Wall Street and investors a glimpse into future revenues.

"It's been a long-standing practice of theirs for over a year," said Christopher Galvin, an analyst with Hambrecht & Quist. "They receive a portion of their revenues up front and defer the rest for 12 to 18 months...It's a more conservative accounting practice because they're taking their costs up front."

Analyst Neil Herman with Salomon Brothers said the deferment of revenue may contribute to Microsoft receiving a higher price-to-earnings multiple.

"Although intuitively one might be concerned that these conservative policies would lower earnings per share and share price, I don't believe this occurs because Microsoft's price is accordingly given a higher PE multiple as a result of these practices," he added.

Oracle, an Informix competitor, does not recognize revenue from its resellers until the end user pays the distributor and a check has made its way back to the database company, said Catherine Buan, an Oracle director of investor relations. The company receives 30 percent of its revenues through its indirect channel.

Herman described two concerns that arise out of Informix's accounting methods.

"One issue is that the company recognizes revenue when it sells product to its indirect distribution channels and this makes it more difficult to gauge real demand for their software," he said. "The second issue is that they exchanged some of their software for hardware with some resellers and this was recognized as revenue. You ended up with the same problem [in gauging product demand]."

But Jeff Hudson, vice president of business development and product marketing at Informix, noted that it does not do pure barter transactions in which no money passes hands. He said cash was exchanged between Informix and resellers for both the hardware and software and that the pricing was at fair market value.

This method was used for a particular program, and Informix plans to consider the same strategy if needed in the future, he added. "Our [accounting] decisions are a good one to grow out the market and block out the competition."

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