IFRS Meets Tech

The seismic shift in accounting and reporting that will be brought about by the impending move to international financial reporting standards (IFRS) will have an impact on all U.S. companies, particularly those in the technology sector. While the timing of this shift may be uncertain, the best indicator of what’s to come is the SEC’s proposed roadmap published in November 2008 that points to mandatory filing by U.S. registered companies by Dec. 15, 2014.

Changes in revenue recognition and share-based payments are just two of the areas in which tech companies will feel the impact of IFRS.

In many ways, the underlying concepts of U.S. generally accepted accounting principles and IFRS are very similar. The greatest challenge for CFOs in the technology sector, however, will be the change from a rules-based to a principles-based accounting model—which means a significant change when it comes to judgment. Rules may sometimes frustrate, but there is a certain comfort in finding the right rule and being confident in its application. In contrast, principles-based accounting puts the onus on the user, calling for careful weighing of factors and recording the processes by which conclusions are reached.

Revenue Recognition
International Accounting Standard 18 sets out the revenue recognition requirements of IFRS. The comparison of IAS 18 and Staff Accounting Bulletin
104 demonstrates the similarity of their underlying concepts. While guidance on software revenue recognition is contained in SOP 97-2, it specified that it did not alter the requirements of any APB opinion or FASB statement concerning revenue recognition.

The IFRS requirements are, however, subject to interpretation on a contract-by-contract basis. Multiple-element transactions are a feature of the technology industry. Ongoing services, support, installation and training are almost invariably contracted for with product sales. The key judgment required under IFRS reporting is whether or not an individual contract should be unbundled and accounted for as separate items.

Conversely, in the case of separate contracts, there may be an argument for linkage. In some circumstances, separate contracts for products, services and support require to be evaluated as a single multiple element arrangement. The questions to ask that determine these circumstances are: Are these deliverables separate units? What is the fair value of the separate deliverables? How and when should revenue be recognized?

Substance over form is the overriding principle of IFRS. The legal structure of the transaction is not the prime consideration. When an arrangement involves multiple deliverables, the arrangement consideration should be linked to each of those deliverables. There has been little guidance as to the specific indicators companies should consider regarding the linkage or separation of transactions in IFRS. The basic principle of IAS 18, however, is that separately identified deliverables should be separated for accounting purposes on a fair value basis.

Unlike U.S. GAAP, IAS 18 does not have a specific ruling against the inclusion of contingent revenue. It does, though, address the subsequent servicing of a product. There is a specific requirement that the amount is deferred and recognized over the period during which the service is performed. The deferred amount will be the expected cost of the services together with a ”reasonable profit” on the services.

Again, unlike U.S. GAAP, IFRS is not prescriptive regarding the fair value method to be adopted. The potential advantage for tech companies is that they will have more flexibility, which may provide an opportunity to change their fair value approach. IFRS permits a cost-plus approach in certain circumstances as a basis for measuring the fair value of undelivered accounting units for the purpose of allocating the total arrangement consideration. Companies may decide it beneficial to change their policy to provide for earlier revenue recognition, with less deferral than under the more prescriptive U.S. GAAP methodology.

Implications of Revenue Changes
The implications of the accounting changes are the different trigger points for revenue recognition. At the time of transition, companies will need to perform a wholesale review to identify long-term contracts and consider whether they are affected by the changes.

On an ongoing basis, an overall organization policy will be needed. The change to a cost-plus approach will require specific and clearly documented accounting polices as to what may be included in cost and how a reasonable profit margin may be recorded. Product cost in the technology sector tends to be inseparable from a long history of research and development cost. Accounting policies will need to be established with regard to the allocation of this cost between products and to subsequent upgrades and enhancements. For many companies this will require new data collection systems to capture and allocate costs by product line in accordance with their new accounting policies.

Share-based Payments
Share-based compensation is a key part of many tech companies’ compensation strategy, and though IFRS is conceptually similar to U.S. GAAP, there are differences. The one with the deepest implications is the treatment of graded vesting awards.

Where companies have an accounting policy choice under U.S. GAAP, IFRS is specific in its accounting requirement. Graded vesting awards must be recognized on a tranche-by-tranche basis. In performance metric terms, this leads to a front-loading of the compensation cost. In practical terms, this will call for system changes to record and collect the data for each tranche. Companies may well take the opportunity to reconsider their stock-based award programs.

IFRS Implementation Committee
Preparation for IFRS can be seen as a number of steps, with overlapping responsibilities from different areas of the company. The selection and formation of the company’s IFRS implementation committee is a vital step, and high-level accounting representation needs to be at the forefront.

The initial step is to analyze existing accounting policies for revenue recognition, develop new policies as required, then implement and monitor the new processes
and controls.

The implementation committee also needs representation from executive level IT so changes in hardware and software requirements can be met, and  from communications, human resources and training to manage stakeholder expectations and ensure policy changes are introduced and understood throughout the organization.

Conclusion
It’s not a matter of “if” regarding the move to IFRS, but “when.” And with early awareness and a coordinated program, the transition for tech companies can be a smooth one. 

Christine Miller, CFA is a principal at Tatum, LLC