Accounting Treatment of Software: Intangible but Vulnerable

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Companies today are highly dependent on complex information technology systems. This trend of relying on the system has grown gradually, but the downside of it is that it has made most companies’ asset base vulnerable. The machinery that used to represent much of the tangible asset base for most companies in the olden days has since been replaced by intangible assets that come in the form of software applications.

Currently enterprise resource planning and supply chain management systems are out of sight, but still play a substantial part in revenue and profit creation or generation. Their impact on a company’s ability to function and retain their reputation is very much tangible and this will usually manifest itself when they breakdown (Batchelor).

Many companies are accused of poor management of their software “estate.” This may involve a network of interlocking applications of different eras, which are complicated by attempts of making patches and work-arounds aimed at meeting the immediate needs of a business. If companies poorly understand the licensing arrangement stipulate, they may end up paying massive amounts and at times double the initial cost for permissions they are already allowed.

They may also at times incur extra charges or costs when they opt to extend the use beyond what is within the permitted range. Finance directors are torn between capitalizing their spending on licensing arrangements on software, which at times can considerably long-term, or whether to account for this spending as an operating expense. Analysts believe that capitalizing your IT spending shows that a person believes that it has the potential to deliver future value.

Critics of this proposal claim that it can cause unforeseen problems, and therefore, capitalizing on the IT should not be seen as a way to deliver future value. According to Mike Mobby, who is a partner as well as the lead of the finance consulting practice at Deloitte, a business consultancy group, “There is a trend to treat IT as an operating cost” (Batchelor).

He continues and says that, at times we have situations where projects undertaken have not yielded the expected results and, therefore, companies have ended up having material write-offs since they have already capitalized their spending. The fast moving trend into cloud computing has done a lot in strengthening the belief and the way people view IT. People are gearing up towards appreciating and treating IT as an operating expense rather than investing heavily on IT assets such as hardware and the software needed (Batchelor).

Companies have the chance to buy their computing needs from external service providers and do the work at a cheaper price. According to Stewart Buchanan the vice president of research at Gartner, “Some organizations like to be asset-light, so they outsource their needs.” (Batchelor).

As a person who has spent most of his life in the IT industry Gartner is a force to reckon with. He continues and says, “There has to be a long conversation with the chief financial officer about the assets and liabilities. Many are concerned about liabilities and want to know how much to put in provisions” (Batchelor).

The IT system poses a risk to organization and may make companies vulnerable to attacks. They should therefore be treated the same way organizations treat their accounting practices. Consultants and analysts are reported as having increased their interest in the way companies and organizations manage the risks they face from their IT assets. Also not left behind are credit rating agencies who have also taken a keen interest on the same.

Mr. Buchanan comments that many of the firms around do not have mechanisms in place or life cycles for the pieces of software that they use. He continues and says, “If they have it for the main software applications, they may not have it for the next layers down the stack. Organizations need to understand that their software will ‘wear out’ at some stage” (Batchelor). The companies face the risk of having their software vendors or manufactures going out of business, taken over or losing interest in the product sold.

This can pose a great challenge for the companies because this may mean that support for the product, hardware or software is no longer available for crucial parts of the company’s IT network. If the company then decides to upgrade or modify their system, then this may mean this part no longer works as well with the new parts of the new system and may become, therefore, redundant.

This is a complex problem as Mr. Buchanan explains, “Clients who take their eyes off the ball may find they lose control of their IT functions and they have to throw money at the problem to fix it. Managers should plan for contingencies just as they do with their supply chain or their manufacturing activities” (Batchelor).

From the point of view of Jim McGIvern, “There is the potential for huge liabilities if you are sitting on a mainframe or an old system that is no longer fit for purpose, no matter how much you maintain it” (Batchelor). Jim is a senior business consultant working for AutoReck, a company that specializes in providing data management services to financial organizations and banks.

Another challenge that faces companies and organizations is the complexity in managing licenses. Most times it is impossible to buy a soft ware and the only option company have is to buy specific and limited licenses to use the software. Companies run the risk of being billed by their software vendors if they use the software beyond the license, despite at times they may not know they are abusing the licenses.

Vendors are facing increasing financial pressure and in turn they focus on companies and try to get them enforce licensing arrangements when they are violated. Problems usually arise when companies exceed the agreed number of users of certain programs or allow their employees to join the office network via their phones. At times like this, companies may find themselves being sued by the vendors who are going to claim damages.

With the increase in use of mobile phones and smart phones, a challenge arises in various business models. For example, publishers of books or magazines are delivering content digitally to computers and phones. The problem comes when they want to set a cost for the service as well as problem with allocating costs, including royalties.

This at times will push companies to overhaul their systems such as the accounting systems. This risk is real for every company that uses licensed software and therefore companies are warned to follow and stick to the licensing agreements (Batchelor).

Works Cited

Batchelor, Charles. “Accounting treatment of software: Intangible but vulnerable.” Financial Times. 2011. Web.

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Accounting Treatment of Software: Intangible but Vulnerable

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