Accounting for corporate accountability - Essay Example

Introduction Post-modern corporate business has become a powerful and significant economic force in the industrialized world. Accounting practices are currently focused on corporate accountability, which involves the knowledge and understanding of current concerns regarding responsibility and accountability to stakeholders. Post-modern business discourse is focused on the economic and social consequences of corporate practices (Elliott and Elliott, 2006). Transparency, though, must also take into account the subjective nature of gathering, analyzing and presenting data as published accounting information. The fear that corporate managers might act contrary to the interests of shareholders and not be concerned with those with whom the corporation contracts (creditors, workers and consumers) is of primary concern (Benston, 1982; Schreuder and Ramanathan, 2002). Others may be harmed by corporate actions (externalities). The ways in which social responsibility accounting can be used to measure and serve as a means of controlling externalities is of research interest. Revenue recognition practice is an ambiguous accounting term, in that there is to date, no internally standard definition. This complicates the process of making comparisons within and across companies. A popular characterization of the concept is that revenue recognition practices are revenues that should not be recognised by a company until it is realised or realisable and earned by the company (Elliott and Elliott, 2006; Turnover, 2001). A revenue recognition practice must follow two criteria; a) future economic benefit will flow to or form the entity; and b) there is a cost/value that can be reliably measured (Leo, Hoggett, Sweeting, and Radford, 2005, p. 75). Revenue provides objective evidence to support changes in value if they are reported as revenue. In accrual accounting revenue is synonymous with "income". At some point with in each business revenue is recognised as earned due to sufficient evidence being provided. The International Accounting Standards Board (IASB) uses the term "income" at times to substitute for the word "profit," so care needs to be taken as to the context in which it is used (Deegan and Unerman, 2006; Leo, et al., 2005). The IASB requires four tests: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity: (c) the stage completion of the transaction at the reporting date can be measured reliably; and the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (Leo, Hoggett, Sweeting, & Radford, 2005, p. 75). This paper aims to review the recognition revenue of iSOFT in 2006, which had a revenue recognition adjustment of 174 million due to overstating revenue for long term contracts. A change in accounting policy by the board for future recognition has been implemented in the 2006 Report. And goodwill impairment write-off has resulted in a loss for 2006 financial year. Investigation continues into these issues. A brief background of ISOFT Corporation will first be provided. Secondly, a critical review of the consequences of the change on economic and social dimensions will be presented. Finally a conclusion will synthesise the main points and show support for an internationally standard definition of revenue recognition, and for the adoption of accrual accounting methods. Background of iSOFT. iSOFT is a global leader in the supply of medical software for health care services. Over 8,000 organisations across 27 countries use iSOFT products and services; an innovative company with several target markets specializes in software design, development and solution delivery (iSOFT Annual Report, 2006). During the latter half of the 2006 financial year many changes were taking place for iSOFT, and the January trading statement, together with a related trading update issued on 28 April 2006, had a negative impact on the Group's share price. These events are attributed to the UK National Health Service that has made a shift to patient-centred and integrated health care services, with subsequent delivery and implementation disruptions to the National Programme for IT (NPfIT), which has been an external constraint on iSOFT's activities. In June 2006 the iSOFT board decided the Group's accounting policy for revenue recognition needed to be changed to reflect contemporary corporate needs. Traditionally, the company provided software to independent hospitals and family doctor trusts. Based on the accounting policies that iSOFT used previously, the Group would have recorded revenues of 214.0 million for the year ended 30 April 2006, which was within the guidance range given in the trading statement issued on 28 April 2006. This was below the figure of 262.0 million reported for the previous financial year, mainly as a result of delivery delays under the NPfIT in England (iSOFT Annual Report, 2006). Profit before tax and goodwill impairment under previous policies, would have been 16.4 million (2005: 44.5 million). Recently, the Group has established contracts with mush larger organizations, involving more complex and longer-term projects. As such, it has become increasingly difficult to differentiate between the supply of product licenses and their implementation. Hence, the Board concluded that the previous policy for recognition of revenue was obsolete and has decided that license revenues will in future typically be recognised over the period of implementation, which may range from a few months to a number of years from contract signature, and over the full contract duration in the case of bundled services (iSOFT Annual Report, 2006). Bundled products allocation methods are numerous; stand-alone revenue allocation method; incremental revenue allocation; and other revenue allocation methods, where management has devised its own alternate method (Horngren, Foster, & Datar, 2000). Using a weighted method or alternative agreed upon method can result in revue allocation of bundled products. In the case of iSOFT, the Board chose to devise their own revenue allocation method. The nature of the contracts underlying the revenues of the business determines the way in which revenue should be recognised. In the case of implementation projects the license and implementation revenues are appropriately recognised over the implementation period. In the case of bundled contracts the total revenues of the contract (including license) are appropriately recognised over the total duration of the contract (iSOFT Annual Report, 2006). The judgment of the Board is that this is the most appropriate way for the Company to recognise revenues on projects. Economic Consequences The change to revenue recognition policy was implemented by way of a prior year adjustment as mandated by International Financial Reporting Standard 1. The restatement has reversed revenues of 76 million, 54 million and 44 million (total: 174 million) which were recognised in the years ended 30 April 2005, 2004 and 2003 or earlier, respectively (iSOFT Annual Report, 2006). In future, these revenues will be recognised as determined by the new policy. However, there are limitations to the historical data notably that of the 174 million revenues reversed; approximately 40-50 million will be recognised in each of the years ending 30 April 2007 and 2008, and the majority of the balance in the following three years (iSOFT Annual Report, 2006). The main advantage from changes to revenue recognition policy is that revenues will be a more accurate description of the Groups trading activities, and so be better fitted with operational cash flows for the financial year 2009 and beyond. In the short-term the revenue has been written back for two years from a subsidiary company and will be recognised in next year's statement. So the money has not been lost as the incorrect accounting methods had been in use to recognize the revue of a subsidiary company. Although iSOFT has made a loss this year, it is unlikely to occur next year as the events that triggered the downturn were on-off; it was an abnormal loss. Additionally, iSOFT appears to have a low level of minority investors, and the corporate investors that are shareholders are usually not interested in paying a premium to have regular dividends, as their goal is to accumulate share values, earnings per share, and reinvestment policies with dividends (Alexander, Britton and Jorissen, 2005). However, there is a massive loss of 350 million from impaired goodwill (see Appendix). This may be related to rapid technological advances and software changes, so that many of iSOFT's acquired products and services have become obsolete, and the good will no longer has any value. This may explain the 12% drop in share price in October 2006, as pictured in Figure 1 (iSOFT.com, 2006b). The Board has decided to write off the goodwill. Figure 1. iSOFT Share price pattern in October. The Financial Statement for 2006 is to reassure investors that the company has a long-term future, despite the loss for this year. Presenting ways in which the Board intends to control for the loss (e.g., changing recognition policy, writing off goodwill) aims to stop investors from selling shares, which lowers their value if they sell. Social Consequences Foremost, the impairment of goodwill has led to massive cost cuts and the projected loss of 150 jobs to counter the lower asset to share ratio, triggered by the devaluing the company asset. Also, there are a large number of different internal divisions within the iSOFT (e.g., software design, marketing, administration), which is to be restructured which will support the loss of jobs to cut costs. Other assets that are deemed as no longer needed will also be sold off. The retrenchment of employees completely ignores iSOFT's corporate social responsibilities (CSRs) in terms of people, jobs, employee welfare, organisational culture and community spirit. Such a move goes against the grain of all post-modern discourse in the business arena pertaining to social and environmental protection, care and justice. Also, iSOFT's policy CSR policy aims to operate in an environmentally and socially sustainable way so as to provide a strong foundation for future growth and development of the company. The policies incorporate practice guidelines to attract and retain knowledgeable, high performing employees, so the intended action to lay-off staffs runs counter to established policy. Another social consequence of the changes to recognition revenue policy is overstating agency risk; iSOFT has made a specific management decision as to when to recognise the revenue at different stages, another subsidiary company has inflated revue using creative accounting methods to show a great profit return. Management executives work on a bonus system, and it appears that personal interests of a company Manager have attempted to increase profits. The investigation concerns several contracts where it would appear that revenues have been recognised earlier than they should have been in the financial years ended 30 April 2004 and 2005 under the accounting policy in force at that time. The irregularities uncovered to date do not appear to have affected the cash position of the Group. Hence, the Board chose to suspend the Group's Commercial Director, pending the outcome of a formal inquiry. This seriously affects the overall 'health' of iSOFT's corporate culture, in terms of the values, beliefs and behaviors that management models for other employees, given their roles as leaders within the company (Powell, 1995). Agency theory provides an explanation for the underlying processes of why a manager would not want to engage in an activity that would be of benefit to company stakeholders (Gill & Jones, 2004). The theory stipulates that managers may have personal goals that do not align with those of the company as a whole, and so the manager may look to achieve outcomes that are not in the best interest of other stakeholders. In such a case, a manager might take advantage of available information asymmetry to mislead stakeholders and to increase the private interests of the manager at the expense of other stakeholders. For this situation it may seem obvious that the manager needs to be let go, as the personal agenda could seriously negatively affect the profitability of the company, the moral of employees, and the perceptions of customers of the company brand (Schlickman, 2003; Schroeder, 2003; Swift, 2001). However, it may be that the manager requires ongoing training to realise that quality management practices do not threaten the manager's status or ability to perform at a high level. A focus on continual improvement would provide opportunities to expose the manager to new ways of thinking, and would perhaps cultivate a spirit of accountability, creativity and motivation to become more involved with stakeholders due to reciprocal relationships. Conclusion Evidently revenue recognition is an ambiguous term, with definitions varying both with and across corporations. This paper reviewed the changes in revenue recognition policy for ISOFT Corporation in 2006 that had an adjustment of 174 million due to overstating revenue for long term contracts. The Board deemed policy changes as necessary to align the Group with contemporary accounting accountability focus. The Board has chosen its own revenue allocation method due to the complexity of longer-term projects, some having ongoing payment agreements. Economic consequences have included; approximately 40-50 million to be recognised in each of the years ending 30 April 2007 and 2008, and the majority of the balance in the following three years; a massive loss of 350 million from impaired goodwill; reduced asset worth; and a drop in share prices. Social consequences have included; the intention to retrench at least 150 staffs; possible loss of confidence in management by staffs; possible loss in confidence in CSR policies by staff and the community; possible loss of confidence in the brand by shareholders due to increased agency risk. However, as this was an abnormal loss for iSOFT, dividends are expected next year and following years. It is conceded that this paper shows the necessity for an international definition of revenue recognition practices to control for creative accounting and management making decisions based on personal interests. References Alexander, D., Britton, A. and Jorissen, A. (2005) International Financial Reporting and Analysis, London: Thomson (2nd edition). Benston, J. (1982) Accounting and corporate accountability, Accounting, Organizations and Society, Vol 7, Issue 2, pp. 87-105. Deegan, C. and Unerman, J. (2006) Financial Accounting Theory: European Edition, Maidenhead: McGraw Hill Elliott, B. and Elliott, J. (2006) Financial Accounting and Reporting, Harlow: Prentice Hall (11th edition). Gill, C. W. L., and Jones, G. (2004). Strategic Management Theory an Integrated Approach, (6th Edition). Boston: Houghton Mifflin Company. Horngren, C., Foster, G. and Datar, S. (2000) Cost Accounting: A Managerial Emphasis, Prentice Hall International, Saddle River, NJ. iSOFT (2006a) iSOFT Annual Report, 2006. http://www.isoftplc.com/corporate/investor_centre/830.asp (Accessed 23 October, 2006). iSOFT (2006b) Current share price. http://www.isoftplc.com/corporate/investor_centre/index.asp (Accessed 23 October, 2006). Leo, K., Hoggett, J. Sweeting, J. and Radford, J. (2005) Company Accounting (6th edition), John Wiley & Sons, Sydney. Powell, T. C. (1995). Total quality management as competitive advantage: A review and empirical study, Strategic Management Journal, Vol 16, No. 1, pp. 15-37. Schlickman, J. (2003) ISO 90001: 2000: Quality management system design, Artech House Norwood, Ma. Schroeder, R. (2003) Operations Management, 3rd ed. McGraw-Hill, New York. Schreuder, H. and Ramanathan, K. (2002) Accounting and corporate accountability: An extended comment, Accounting, Organizations and Society, Vol 19, Issues 3-4, pp. 409-415. Swift, T (2001) Focus on Social and Ethical Auditing Trust, reputation and corporate accountability to stakeholders, Business Ethics A European Review Vol 10, pp. 16-20. Turnover, L. E. (2001) Speech by SEC Staff: Revenue recognition. http://www.sec.gov/news/speech/spch495.htm (Accessed 23 October, 2006). Appendix Table 1. iSOFT costs including Goodwill Impairment (iSOFT Annual Report, 2006a, p. 109). Read More