Second IBM Probe Reveals Accounting Perils of Services Business

  • SEC is looking into transactions in the U.S, U.K. and Ireland
  • Rest of industry `got to be worried' about revenue recognition

IBM’s Ginni Rometty is grappling with the second federal probe into revenue recognition in as many years -- evidence of the accounting challenges technology companies like hers face as they shift from selling hardware to software services.

International Business Machines Corp. disclosed Tuesday that the U.S. Securities and Exchange Commission is looking into the accounting treatment of certain transactions in the U.S., the U.K. and Ireland. Last year, the SEC ended a different probe into how the company reports revenue from offsite cloud services without recommending enforcement action against the Armonk, New York-based company.

While IBM hasn’t elaborated on what the new investigation involves, accounting for some emerging technologies presents challenges. For instance, providers can book revenue from licenses immediately, but sales of services can only be recorded when they’re delivered, even when the customer pays up front, said Michael Cusumano, a professor at the Massachusetts Institute of Technology’s Sloan School of Management.

Enormous Temptation

“If sales are slow, the temptation is enormous to classify some of those revenues in the license or subscription bucket, but maybe some are really professional services instead,” Cusumano said. “It makes their product sales look better.”

After Rometty became chief executive officer in 2012, she began moving IBM away from its traditional mainframe and server business into faster-growing cloud computing and data analytics technology. IBM is banking on the newer operations to deliver $40 billion in revenue and account for 40 percent of total sales by 2018.

Hitting that target is by no means assured; last week IBM cut its full-year profit forecast and reported the 14th straight quarter of shrinking sales.

Daryl Plummer, chief of research at Gartner Inc., said tech service contracts are getting shorter these days even as companies shift more to the pay-as-you-go model, which has implications for how and when they book sales. He predicted other tech services companies will be investigated.

Industry Challenge

“IBM is the canary in the coal mine,” Plummer said. “Everybody’s got to be worried about doing everything by the book, and the SEC may take a look anyway.”

SEC spokeswoman Florence Harmon declined to comment.

IBM said it’s cooperating with the SEC and that the company is confident that its financial reporting is appropriate and consistent with generally accepted accounting rules. Spokesman Steve Tomasco said the current inquiry is unrelated to the cloud revenue probe.

The shares fell 4 percent Tuesday, to a five-year low of $137.86.

It’s “disconcerting” that the reliability of financial information from big companies like IBM “is being called into question,” said Ivan Feinseth, the chief investment officer at Tigress Financial Partners.

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