JDA Software is an established vendor of (among other categories) accounting software for the retail sector. So it is a bit ironic that the company is in the process of restating its earnings for 2008 through 2010 because of revenue recognition practices that led it to book some revenue sooner than it should have. The issue centers on certain transactions the company linked to service agreements and license revenue. As well, in 2009 and 2010 some of its license contracts included a clause protecting customers if certain products were discontinued, which can be construed as promising a future deliverable that would have required a delay in recognizing some or all revenue from those license contracts. Also, JDA is re-evaluating vendor-specific objective evidence (VSOE) for its Cloud Services in 2008 through 2010 to determine whether it met the appropriate requirements to recognize revenue at the start of those contracts; otherwise revenue would have to be prorated over the life of the contract. For a public company, any accounting restatement is serious, and JDA’s stock price has declined since the start of the year, but this seems to be due more to a fourth-quarter 2011 revenue shortfall relative to expectations and a downward revision in earnings expectations than to the restatement. The changes it is likely to make are more optics than substance, which accounts for the muted response from the market.

While it remains to be seen how JDA will fare in the restatement, I think its predicament has applicability for many companies and their finance departments, in the technology industry and elsewhere.

Accounting for the sale of intellectual property can be a slippery thing. Many software companies’ revenue recognition policies were extremely aggressive until 1991 when the first standards were put in place. Those first iterations proved too feeble, and further revisions attempted to prevent abuse, but in the process the rules have become highly detailed, and it’s easy to make mistakes trying to abide by accounting regulations that have more than 100 requirements governing recognition of revenues and gains. Partly to remedy this complexity, the U.S. Financial Accounting Standards Board (FASB) is looking to simplify these rules and move to more of a principles-based approach as it harmonizes U.S. accounting standards with the broadly adopted International Financial Reporting Standards (IFRS). (I covered this topic earlier this year). But for the time being, rules are rules. Especially because accounting for revenue in software is so tricky, companies must make extra effort in implementing and maintaining processes. Documentation must be thoroughly reviewed and vetted by auditors (and based on experience, I’m afraid even that isn’t an ironclad guarantee of compliance).

The shift to more of a principles-based approach in U.S. accounting standards is necessary. In the case of revenue recognition, the current rules can obscure economic reality rather than reflect it, giving professional investors an edge over others because they have the ability to see through the reported numbers (this is the exact opposite result of FASB’s stated intentions). Worse, in this case it can distort (and to my knowledge has distorted) the behavior of software companies, keeping them from making decisions that would benefit shareholders because of the negative impact those choices would have on reported revenues and earnings.

Another important point may be found in JDA’s efforts to address accounting process issues in a more comprehensive fashion. According to its CFO, JDA is implementing an end-to-end “opportunity-to-cash” process, which connects each step of a business process as it crosses departments and cuts across multiple IT systems. By smoothing handoffs between participants and linking necessary data from one step to the next, automating the progression from identifying a potential customer to closing a deal and collecting the cash can be performed faster, more efficiently, with fewer errors and with greater customer satisfaction than an approach that is not integrated. However, our research finds that too few companies have deployed such automated processes. Although implementing end-to-end processes (other examples include “requisition-to-pay” for purchasing and “hire-to-retire” in HR) is not simple, I believe inertia is the main reason why many corporations have not embraced this approach.

It shouldn’t take a crisis to drive change, especially when timely change can avert crises. I urge finance departments to re-examine how they do things on a regular basis. In my judgment, the reflexive “we’ve always done it this way” mentality is the most common barrier that prevents Finance from operating more efficiently and effectively. I believe every CFO should review major processes at least once a year to assess opportunities for improvement. Identifying ways to use existing information technology must be part of this effort, since only a minority of departments fully utilize these resources. Unfortunately, human nature being what it is, it often takes a crisis to force finance departments to act. In the 10 years that Ventana Research has been doing benchmark research, I’ve seen little evidence of substantive improvements in major processes; as just one example, the financial close now takes longer than it did five years ago. There’s a lot of lip service paid to change but as usual, when all is said and done, more is said than done.

Regards,

Robert Kugel – SVP Research