Xero responds to questions over narrowed loss

On Friday, Xero reported its annual result. Revenue tripled, customer numbers doubled, and its loss narrowed by $700,000 to $7.6 million from the prior year’s $8.3 million.

In a comment after our original story, an NBR reader pointed out a footnote on page 6 of the online accounting software company’s condensed accounts – namely, a decision by the board to redefine the useful life of Xero’s software development efforts from three to four years to three to five years, an adjustment that saved the company $880,000 in amortisation costs.

Without the adjustment, Xero's loss would have widened by $180,000 (chief executive Rod Drury told NBR that the company was “investing to plan” and was still on track to break even, as promised, by the end of this year).

Why the amortisation change?

Mr Drury said “That actual question is a good one”, but refused to answer it directly on the grounds that it was posted anonymously.

The chief executive, who left several comments after NBR's Friday story, added, “I don't agree with NBR's policy of allowing anonymous comments. I hate to think of young people being put off doing public companies as the NBR has now become the Wild West. I don't see how that is good for NZ business.”

The Rich Lister did, however, point NBR to a discussion thread on Xero’s website, where general manager of finance Paul Williams addressed the issue yesterday. Mr Williams wrote:

A few people have asked over the weekend about the background to the change in amortisation period. These are sort of questions we welcome as it is relevant to all software companies .

Each year we complete a review of the carrying value of the software asset in our books and over what period in accounting speak that “this will generate future economic benefits”.

As part of the current year’s review we noted that the initial code we wrote in 2007 and 2008 is still at the heart of the application today. This together with the fact that Xero product is now much more mature, reinforced that the useful life over which the software development cost was being amortised was longer than the existing estimate and should be increased. Accordingly the Board of Xero chose to increase the estimated useful life period from 3-4 years to 3-5 years resulting in a lower amortisation cost of $880,000 in 31 March 2011 audited financial statements.

The capitalisation and amortisation of software development costs is a core issue for software companies and there are many approaches ranging from the US general policy to write off all development costs as incurred, to the UK/Australia/NZ policy of capitalisation and amortisation over a range of years.

Xero shares (NZX: XRO), which were trading at $2.48 before the company's result was reported Friday, closed flat yesterday at $2.50 against a broader market dip of 0.66%.

BELOW: Xero 12-month chart courtesy NZX.com (click to zoom):