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Journal of Indian Institute of Management Bangalore

IIM Bangalore offers Degree-Granting Programmes, a Diploma Programme, Certificate Programmes and Executive Education Programmes and specialised courses in areas such as entrepreneurship and public policy.

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The Indian Institute of Management Bangalore (IIMB) believes in building leaders through holistic, transformative and innovative education

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Revenue Recognition in the IT Industry

Volume 18, Number 3 Article by Vishal P Agarwal September, 2006

Revenue Recognition in the IT Industry :

Revenue is the most important figure in the financial statements of any company. Stock prices of companies are dependent to a large extent on the revenue achieved as well as the guidance for the subsequent year. Most financial frauds involve improper revenue recognition. While various standards have been issued both under Indian and US GAAP to protect the interest of the investors, accounting standards are always evolving. Due to the nature of contracts in the software industry and the global delivery model, there are some aspects of revenue recognition which are not covered by the accounting policies. The absence of a standard practice can hamper comparison between firms. Further, the absence of an accounting policy to require disclosure of such estimates and changes in estimates hold back critical information from the investors.

In this award winning student essay, Vishal Agarwal describes the nature of contracts in the software industry, and argues that additional measurement and disclosure standards may be required to protect the interests of investors. Beginning with a discussion of the disclosure requirements of the Indian and US GAAP, he goes on to describe the types of contracts. Among the commonly used types of contracts, Time and Material contracts are comparatively uncomplicated, while the Fixed Price Project (FPP) model involves a lot of estimations, particularly in the ‘Percentage of Cost Completion’ method. The resulting complications include the absence of standard norms for estimating required man hours, variations in practice in calculating offshore-onsite cost ratios and the lack of disclosure requirements for non USD contracts. These inconsistencies are described in detail and appropriate measures suggested. The disclosure issues discussed in the paper are applicable not only to companies which do not follow comprehensive disclosure policies, but even to companies that are generally considered to follow ‘progressive’ disclosure policies.

Reprint No 06302