IBM and others facing the cloudy business of accounting for the cloud

IBM and others facing the cloudy business of accounting for the cloud

By Michal Lev-Ram, writer August 8, 2013: 11:00 AM ET

More questions than answers have been raised about methods used to account for software-as-a-service products.

FORTUNE — Last week’s disclosure that the Securities and Exchange Commission is conducting an investigation into how IBM reports its cloud computing revenue poses more questions than answers. The New York-based tech giant admitted it has been cooperating with the SEC since last May but said little else about the particulars of the case. One thing is clear: It’s likely this won’t be the last probe into the often inconsistent methods used to account for software-as-a-service products.The cloud itself isn’t the problem — it’s the way it happens to be packaged and sold. Unlike traditional, on-premise software, cloud-based tools are usually paid for via multi-year contracts. Customers are charged a monthly subscription fee, which means a recurring revenue stream that can be tricky to account for because it spans the course of several years (and because, sometimes, customers back out of contracts). This gets especially complicated at large companies that lump cloud-computing sales in with non-cloud products.

“Accounting rules were written when we were all trading goods with each other,” says Tien Tzuo, CEO of Zuora, a billing platform used by many cloud computing companies. “As we move away from a manufacturing economy to a service economy it gets pretty complex.”

IBM (IBM) may be a good example of this phenomenon. Over the past few years, the company has been shifting from its roots as a hardware and on-premise software vendor, toward a future as a cloud and services purveyor. To that end, it’s made several acquisitions, including a recent $2 billion bid to acquire SoftLayer Technologies, which rents out computing power to customers.

“Any time you put two companies together, it’s reasonable to expect that they will have slightly different accounting practices,” says Cowen & Co. analyst Peter Goldmacher. “These are different companies with different policies and different revenue models. You’ve got an involved situation made complicated by taking different delivery models and accounting practices and putting them together.”

That’s not the only problem for companies like IBM — and Oracle (ORCL) and SAP (SAP) — that have made acquisitions in the cloud computing space. This clash of cultures also complicates commissions, because salespeople used to selling traditional software are used to collecting a hefty, one-time check for every deal they close. And while embracing these new, high-growth technologies are a necessary evolution for so-called legacy companies, it’s not clear just how much money they’re actually making from the cloud because these fledgling businesses are often bundled with other, non-cloud products. IBM, for example, has said its cloud computing business was up 70% during the first half of this year. But it hasn’t given any frame of reference because it doesn’t actually break out what those revenues used to be or are currently.

It will likely be a while before investors can tell exactly what these large tech companies are making from these new businesses and how well they’re folding in their cloud-based acquisitions. Even cloud heavyweight Amazon.com (AMZN) isn’t yet required to break out revenue from its growing cloud computing products, Amazon Web Services. According to Cowen & Co.’s Goldmacher, investors should pause before becoming too enamored with subscription-based revenue, however attractive a recurring revenue stream may seem: “… we are concerned that investors are taking false comfort in these models because the income statement and balance sheet can be lagging indicators on the real trajectory of the business,” he wrote in a recent report. But Goldmacher is also quick to note that it’s unlikely anything nefarious is going on, even if the SEC has reason to launch an investigation. “My belief is that this is just really complicated,” says Goldmacher. “The more complicated an undertaking the more likely you are to make a mistake.”

In other words, until these new cloud-computing businesses get large enough to require more transparency — and until accounting practices for subscription-based products become more standardized at all tech companies, large and small- — it’s likely there are plenty more mistakes (and SEC investigations) ahead.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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