A recent change in accounting standards will lead to a revenue boost for many companies that are currently required to defer revenue over several years, allowing some to recognize all the revenue up front at the time of delivery.

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The Financial Accounting Standards Board (FASB) recently changed the rules regarding tangible products containing software elements that are "more than incidental" to the products' functionality. The old rules require the companies to follow a revenue recognition rule that was written for sales of software.

New Rules Must Be Implemented By Q1 2011
The new rules state that tangible products containing both software and non-software elements that function together to deliver the products' "essential functionality" are no longer under the old software recognition rules. The change must be adopted by the first quarter of 2011, but companies may adopt it earlier.

What does this mean in plain English? If a company sold a hardware product for $300 and had to recognize the revenue over two or three years because it contained software elements that are "more than incidental," it may now be able to recognize all the revenue at the time of sale.

Apple Computer (NYSE: AAPL) currently defers part of its revenue from sales of iPhones and some other products over a two-year period. During the company's fiscal fourth-quarter conference call in October, management couldn't quantify the effect of the change but indicated it would likely lead to accelerated revenue recognition.

"We don't know at this time the specific amount of revenue deferral for each iPhone and Apple TV sold under EITF 093, but we do believe that a substantial portion of the revenues will be recognized for these products at the time of sale," said Peter Oppenheimer, Apple's chief financial officer.

Interesting Possibilities
The new rules are complex and must be interpreted by each company individually, but they raise some interesting possibilities. Oracle (Nasdaq: ORCL) is moving its announced purchase of Sun Microsystems (Nasdaq: JAVA) through the regulatory process. If the deal closes and the two companies integrate the respective hardware and software products, could that lead to quicker revenue recognition for Oracle's traditional revenue stream?

Other companies impacted by the change include all the large technology firms, including Cisco Systems (Nasdaq: CSCO), IBM (NYSE: IBM) and Nokia (NYSE: NOK). During its recent conference call, Cisco Systems said that adopting this rule and another change mandated by the FASB increased revenues by $50 million in its fiscal first quarter.

Most of the larger companies have been quiet about the change during the third-quarter earnings season, possibly because the rule change adoption deadline is not until 2011. Westell Technologies (Nasdaq: WSTL), a small-cap technology company, adopted the rules early and implemented them in its most recent quarter reported in October. The change allowed the company to recognize almost all of its revenue from sales of its UltraLine Series 3 Gateways upon delivery, rather than deferring part of it. The switch boosted revenues by $37.8 million over the past 12 months.

Bottom Line
New rules mandated by the FASB will almost surely lead to higher revenues through accelerated recognition. This may come in handy during what may be a sluggish time as the economy emerges from the recession. (Learn about common tricks used in financial statements in our article, Common Clues Of Financial Statement Manipulation.)

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