The challenges of improving revenue-recognition standard for multiple-element firms:evidence from the software industry (SOP 97-2)

I investigated whether implementing SOP 97-2, the revenue-recognition standardfor the software industry, reduces earnings informativeness. This standard is particularlyimportant for two reasons: First, its provisions coincide with provisions of SAB 101, thecurrent general revenue-recognition standard. Second, the software industry provides alaboratory setting for examining multiple-element firms, whose revenue-recognitionchallenges keep mounting as more and more firms bundle multiple products andservices. I found that implementing SOP 97-2 leads to additional revenue deferrals and adecline in earnings informativeness. However, the market prices these deferrals asrevenues, as if these amounts had not been deferred. Moreover, the proforma earnings,which I calculated by undoing the revenue deferrals, more strongly correspond withmarket returns than do the reported earnings. My findings indicate that the accountingnumbers calculated using the pre-SOP 97-2 revenue-recognition rules more stronglycorrespond with market returns than do those calculated using SOP 97-2. My findingsshould interest FASB in its project on developing a new revenue-recognition standard.