The Hazy Outlook for Cloud Accounting

Legacy systems generate legacy problems. Admittedly, they also offer stability, relative certainty and, sometimes, lower costs. But in our haste to avoid the uncertainty of innovative advances we sometimes saddle ourselves with unnecessary complications.

For an often boring subject, measurement remains one of our most contentious management problems. This is understandable because compensation is frequently tied to the way in which performance and its outcomes are evaluated.

This has been especially challenging for the past generation or so, as technology and services have come to dominate the global economy, even in supposedly manufacturing-driven countries like China.

The issue is that we have a pretty good idea about how to cost and account for the inputs and outputs of a piece of machinery made by one enterprise and sold to someone else. Technology and globalization have complicated the situation by imposing a series of intermediaries, interconnections and interventions designed to improve quality and reduce cost. Unfortunately, they have also introduced a fair amount of confusion - or outright dispute - about who should or could be credited with what.

Tax authorities want revenue, politicians want credit for job creation, investors want returns and managers want bonuses based on their contribution to making it all happen. The challenge is, as the following article explains, that determining who should justifiably receive credit for services routed through the cloud, for instance, is not exactly clear - from business unit to business unit, company to company, country to country.

The reality is that given current accounting conventions and the refusal to clear up imprecision due to fear of personal loss or competitors' gain, we may never be certain. But the cost to the global economy due to misallocated resources, mispriced deals and mistaken policies suggests that addressing these issues is becoming more urgent - and more expensive. JL

Michal Lev-Ram reports in Fortune:

While embracing 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.
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.