New Economy Business And Accounting.

The "New Economy" has brought business and accounting issues that are leaving many financial executives perplexed and at a loss for guidance. In an effort to identify the major issues and provide perspective on how they are impacting companies, FE spoke with Barbara Carbone of KPMG LLP.

Carbone is the National Industry Director, Software and Services, in KPMG's Information, Communications and Entertainment practice. She's co-author of a practical book on understanding relevant financial and reporting issues when accounting for e-business, Defining the Digital Future: Business and Accounting Issues.

What's different about accounting for the Internet, e-commerce or applications? Isn't it still just accounting?

Carbone: There's very little that's new, and for the most part, existing accounting rules and practices can be applied to these new types of businesses and transactions. A big difference is in some areas where the Emerging Issues Task Force (EITF) and the Financial Accounting Standards Board (FASB) are saying, "We've never focused on that specifically, and it's becoming more prevalent. Maybe we should consider it and develop some guidance."

A good example is accounting for shipping and handling costs. Ten or 20 years ago, the number was part of the cost of doing business, and it was relatively insignificant to a company. Exactly where and how it was reported in the financial statements of companies varied, but as [a] relatively insignificant [cost], nobody cared. Fast-forward to 2001, when some companies transact all of their business over the Internet and have very [few] costs other than shipping and handling. All of a sudden [this item] becomes significant to the financial statement.

Yet, for a direct mail or catalog business, shipping and handling have always been a big part of the business.

Carbone: Yes, and while there was an existing practice for catalog companies, I don't think people automatically referred to those practices when they were developing dot-com companies' practices. It's as if they saw themselves [doing something] new, so they made it up as they went along. It's become clear there is a lot of variety in practice and a desire for more consistency.

On that point, currently there are differences of opinions, and there will still be differences in accounting -- where costs are classified. But it's acceptable, as long as it's disclosed and as long as a company's policy is stated: "This is the policy we have. We include it in cost of goods sold, or we include it in selling expenses."

Any other major areas?

Carbone: Another area specifically related to the Internet, requiring more thought than a typical company [situation], is the revenue line: What's included on the revenue line, and when is that revenue earned? Answering that question is easy when accounting for a company where you buy products off a shelf; it's clear when the transaction takes place. In today's complicated transactions -- involving software companies or infrastructure companies -- it's not as obvious at the outset just what is revenue and when it should be recorded.

You've categorized five general areas -- based on the majority of questions from your clients -- that impact a large majority of today's companies. Will you review these?

Carbone: For the first, income statement presentation, the majority of questions relate to "What do you record as revenue and when?" and "Do you record revenue gross or net of the costs being incurred?" These questions are due, in part, to the complexity of the transactions but, also, to today's increased importance of revenue. Share values, largely based on the revenue line, have driven increased significance to the revenue line, making it even more critical that this line is reported accurately. The SEC is concerned about making sure that there is no manipulation of that revenue line, because of the impact that reported revenues has on share price.

On guidance for getting it right, there is no clear-cut answer without understanding each individual business -- something that investors probably don't do a lot of. Understanding financial statements and what's in the revenue line entails understanding factors such as: the type of business, the types of transactions they enter into and whether they report gross or net, and why.

The second category: revenue recognition, focuses around timing. This is not new -- it's the accounting concept we've had. The fundamental rule is: you recognize revenue when the earnings process has been culminated. The question asked is, "What have I done to earn that revenue, and have I done everything I need to do to earn that revenue?" As more transactions have multiple elements and follow on services, products, guarantees or other components added to a basic sale, it's often unclear whether [and when] revenue is actually earned.

The third category: capitalization. A question here is: "What do I capitalize when setting up a Web site and a business over the Internet? What do I have to expense? What do I need to capitalize?" Since Web sites are new, in this area there is some new guidance. The EITF applied the existing accounting literature for capitalized software costs to the activities that go around capitalizing, or around Web site development and management.

The fourth category: transactions in an entity's own stock. This, also, isn't new, but it's become more prevalent as the increased number of start-up companies strapped for cash found the rise in the value of their shares a very valuable commodity. We've seen more companies use their stock to transact business. With the slowing economy, there are still transactions with stock, but not at the level there was, when you could even lease office space for shares of stock.

The fifth category: investments and alliances. Entering into and managing alliances is becoming a critical core competency, and not just for New Economy companies. Established companies are looking for potential partners to take advantage of skills, existing technologies and competencies -- they're finding it's a lot easier to partner than to develop something internally. Here, too, the rules aren't new, but as[alliances] become more prevalent, there's a need to focus on what you need to understand when considering alliances.

When assessing the five categories, can you give some specifics?

Carbone: Accounting for capitalization and investments raises questions about the valuation of the assets on a company's books. The rules are pretty clear about what can be capitalized and what can be expensed. The question is: "Is there continuing value in what you capitalize today?" An issue those in the dot-com space are dealing with is, "Is there continuing value in costs they capitalized for their Web sites?" Will they get the return they expected on the millions spent? Are they using the things that they spent the money on, or have they changed direction?

When advertising revenues fell apart, many companies changed business models -- two and three times -- seeking other sources of revenue. Now they need to consider the assets on their books and evaluate whether those assets have continuing value or whether to write them off.

For alliances, partnerships or transactions with securities, the biggest issue clients are struggling with are write-downs; it's a matter of when to take them and how much to take. We've seen a lot of write-downs in this last year-end and even last quarter. The SEC has been very clear that it expects companies to continually monitor the value of their assets. While [the SEC] doesn't want companies to take write-downs too early (that's seen as managing future revenue), it also doesn't want companies carrying assets on their books that aren't worth what they're recorded at.

Have you identified specific accounting issues that have arisen in light of the dot-com debacle and the loss of $4 trillion or so of wealth over this past year?

Carbone: Valuation of assets is probably the biggest issue. Because of the basic model that we have -- of recording things at historical costs and at a fair value that's based on quoted market prices -- the accounting rules have led us to a situation where we have companies with assets [recorded] at inflated market values.

As for the accounting model, it's not that they [companies] did the wrong thing; they followed the rules. So we're kind of stuck, and I don't know that anything will change, as far as the rules go. The biggest change that will occur will be increased disclosure. We'll see financial statements with more discussion on such items as the valuation of assets on the books, what the company does to monitor the continuing value, why they think there's continuing value and increased disclosure about potential risks going forward and that that value may not materialize.