National Accounts Experts’ Meeting 08-11 October 2002

Economic Analysis and Statistics DivisionDirectorate for Science, Technology and Industry

OECD Software Task Force Final ReportNadim Ahmad

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Software Task Force

Background

Definitions and Accounting Framework

Trade

Deflators

Business Accounting; implications

The Supply Approach & Own-Account Estimation

Capital Consumption, Current Yr Estimation

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Background

Figure 2 : INVESTMENT RATIOS Software Investment as a proportion of total business and government expenditure on computer services

(excluding intra computer industry sales)

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

UK 9

9

France

98

Italy

98

Czech

Rep

99

Canad

a 98

Nether

lands 9

8

Ger

man

y 95

Denm

ark 9

7

Sweden

99

Austral

ia 9

8/9

USA 97

Gre

ece 9

8

Spain 9

6

Japan

99

CountrySource: OECD/Eurostat Questionnaire, (Germany from OECD IO database)

Ra

tio

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Background

Set up October 2001 Jointly with Eurostat 19 countries Questionnaire 4 meetings Completed June 2002

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Definitions, Concepts, Classifications

Definitions Concepts & Transactions Concordance Classifications

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Definition - Software

What is software ? 1(1):product classifications should recognise

a single entry for software, covering all the multiple physical and legal formats which support software. This unique entry has two sub-categories: originals and reproduction of originals. Licenses are part of the category reproduction of originals.

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Concepts - Originals and Own-account

All own-account software is investment, 1.(2)

Valuation, should include production costs (excluding asset acquisitions), 1.(3), (4):

- Functional analysis

- Detailed analysis

- Programming

- Testing

- Documentation

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Concepts - Licenses-to-Use & Rentals

SNA 6.143:

• “The production of books, recordings, films, software, tapes, disks, etc. is a two-stage process of which the first stage is the production of the original and the second stage the production and use of copies of the original. The output of the first stage is the original itself over which legal or de facto ownership can be established by copyright, patent or secrecy. The value of the original depends on the actual or expected receipts from the sale or use of copies at the second stage, which have to cover the costs of the original as well as costs incurred at the second stage.”

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Concepts - Licenses-to-Use & Rentals

SNA 10.92:

• “Computer software that an enterprise expects to use in production for more than one year is treated as an intangible fixed asset. Such software may be purchased on the market or produced for own use. Acquisition of such software are therefore treated as gross capital formation.”

SNA unambiguous that software is a 2 stage production process, with 2 distinct outputs, “originals” and “copies”, hence the OECD ‘factory’ analogy.

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Concepts - Licenses-to-Use & Rentals

Software often purchased with conditions or licenses describing these conditions, so TF introduced concept of licenses-to-use to differentiate between copies and reproduction rights. Important to concentrate on properties of the copies, and not exclusively the license.

What is purchased? – Software Reproductions; license mainly prohibits

illegal copying. Analogous to tangible goods, patents, etc & other intangibles, books, tapes, & often sets out time-limits.

SNA 68 treatment? – Bundled/Embedded software copies capitalised.

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Concepts - Licenses-to-Use & Rentals

Clear that copies are distinct from ‘originals’, and are products in their own right, with asset characteristics.

But software purchased in many ways: – Simple up front purchase & no time limit.– Payment for use for longer than 1 year. – Annual payments with large up-front payment.– Regular annual payments.

TF agreed to record these as being owned by the user as long as intention of 1 year + use; 1(7),(8), based on expectations of purchaser. If these satisfy 1-year rule, expenditure=investment.

Alternative would be to record copies as being rented-out by software ‘original’owner; contrary to business practice.

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Concepts - Licenses-to-Use & Rentals

Consistent with – business accounting. – bundled, embedded. – the SNA. – tangible goods: factory, production (the

fact that software reproduction costs are cheaper than conventional (tangible) goods is not a reason to treat them differently, particularly as tangible goods increasingly embody ‘intangible’ traits.

– intangible processes, e.g. books.

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Licenses to Reproduce & Bundles 1(9): That licenses-to-reproduce are treated

as intermediate consumption. Where licenses have duration of longer than one year the usual rules of accrual accounting should be applied. The payment should be distributed over the lifetime of the licensing contract and recorded as payment in advance (F.7 in the financial accounts).

1(10): Any software (including outsourced software) purchased for bundling or embedding into products to be sold on should be treated as intermediate consumption

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Maintenance&Repair - Small Tools

1(12): That maintenance expenditure is classified as intermediate consumption. Maintenance and Repairs that permit software to continue to be used in the same way under normal operating conditions, without including new features for the user, should be recorded as intermediate consumption.

1(13): That the small tools’ rule is retained.

Royalties 1(11) - generic term, concerning payments for software copies and rights to copy.

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Databases

No satisfactory conclusion; implicit recommendation from the TF is to continue as before, namely, not capitalising databases, for now.

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Concordance Tables

Given the earlier conclusions on:– own-account software valuation– bundling/embedding– royalties– one year intention rule– small tools rule– licenses to use, reproduce

software is: – purchases of originals (including games) and

reproduced software (on-the-shelf software, whatever the media), (includes licenses to use and rentals) and own-account software

• CPA 72.20.2, USIC 7372

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Concordance Tables

Software is:

– development (analysis, design and programming) of software for, and to meet the requirements of, a specific client (including self) and – modification of packaged software).

• CPA 72.20.32, USIC 7371

– provision of systems analysts and/or programmers services on a per diem basis to participate in one of the phases of the development of a system. The client supervises and retains the right to their work.

• CPA 72.20.33, USIC 7371

– databases where exclusive ownership rights are transferred.

• CPA 72.4, USIC 7372

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Trade

Trade in computer services, and software, not particularly well defined in international trade classifications.

Not a problem for trade balance but is a problem for Supply based methods

Important therefore to establish clear processes for identifying trade in computer services and software.

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Trade

2(1): ”Computer software" in international trade statistics has three main components:

• software goods;computer services; software royalty and license fee payments.

2(2): Trade in computer services (BoP) code 263) separately identified from “comp & info” services

2(3): Separate identification of software royalty and license fee payments in BoP services classification (part of EBOPS code 266).

2(4): Standard international grouping of Harmonised System (HS) codes representing trade in software goods: HS 852431, 852440, 852491, 852499 (ex 8524390

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Deflation

Investment in software. Price indices from 1995 onwards. 1995=100

60

70

80

90

100

110

120

130

140

1995 1996 1997 1998 1999 2000

SWE

GRC

FIN

SPA

NDL*

FRA

USA *

CAN *

DEN

AUS

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Table 2: Comparison of deflators used for softwareCountry Own-account Customised Pre-packaged

Australia Prices are assumed to fall by 6% a year.Canada Weighted average (2:1) of

programmer labour costsand non-labour inputs tothe computer servicesindustry

Weighted average of own-account and pre-packaged(1:3)

Average of U.S. index forpre-packaged adjusted forexchange rates. A newindex is due for releasenext year

Czech Republic Price indices for the output of the computer services industryWeighted average of labour costs and PC hardware (1:1).Weighted average labour and PC hardware (3:1) Weighted labour and PC

hardware (1:1).

Denmark 1993-95 1996-97

1998 + Geometric average of labour and hardware (3:1)Average earnings index for the computer services industry.Finland 1975-97

1998 + Weighted average of labour costs of the computer services industry and US pre-packaged software index adjusted for exchange rates (1:1).US price index adjusted for exchange ratesFrance 1995 (-)

1995 + Labour costsGreece General (whole inflation) price indexJapan Corporate Service Price Index for “the development of computer software tailored for

corporations”, based on the labour costs.Netherlands Labour costs of ICT

personnel.Producer price index Producer price index

Spain Based on producer price index for office machinery and the general consumer priceindex (excluding renting)

Sweden Average earnings index for the computer services industryUK Average earnings series adjusted for the computer services industry with 3%

productivity adjustment since 1996.US Weighted average (roughly

1:1) of programmer labourcosts and non-labourinputs to the computerservices industry

Weighted average of own-account and pre-packaged(1:3)

Matched-model priceindex with a downwardadjustment of 3.3%

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Deflation 3(1), 3(2): Separate price indices for pre-packaged,

customised and own-account software, adjusted for quality.

In the short term acceptable to use, for,

– Pre-packaged - US price index adjusted for exchange rates etc 3(3).

– Customised - average packaged software & input-cost indices, 3(4).

– Originals for reproduction - pre-packaged price indices, 3(5).

– Own-account - input methods 3(5).

In the long term

– Own-account - preferable to use price indices for customised software instead of Input-price indices, 3(5).

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Business Accounting - Practice

Business accounting largely consistent with SNA and TF recommendations: recognises own-account and purchased.

But businesses v.prudent, e.g little own-account is capitalised.

In practice business accounts produce relatively low investment levels.

Questionnaire asked for Supply vs Demand– Australia 7 times; Canada 4, France 1/3, US 10.

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Business Accounting Implications

Clear that in most countries survey information not currently adequate to fully estimate investment.

4(1), 4(3): Supply based estimates to supplement business surveys, & used in medium-term until 4(2) is effected.

4(2): Business surveys adapted in accordance with TF recommendations.

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The Supply Approach

Long term second best method. Estimates GFCF using commodity flow– Distinct approaches for Purchased & Own-

account.

Purchased - 6 steps.

Step 1: Important to use product, not industry output, sales, including royalties from software in CF supply, 5(1).

Step 2: Add Imports, ensuring that royalties etc are identified within BoP data, 5(2)

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The Supply Approach Step 3: Account for margins, taxes.

Step 4: Allocate to IC (using concordance tables), 5(3):– All categories that are exclusively IC.

– Subcontracting

– Purchases by Bundlers.

Step 5: Estimate Maintenance to IC (if not separately identified in product classification) E.g, US 10-15% of SIC 7371, 5(4).

Step 6: HHFC and Exports (inc royalties) 5(5).

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The Supply Approach Own-Account Estimation.

– Important, contributes about 1/3 of total, 5(6).

– Input method, that takes labour and other input costs of all software professionals only and excludes output engaged in market activities.

Step 1: Estimate total labour costs and exclude costs linked to customised and reproduction software…. but not originals, and exclude any costs not linked to software production, e.g, maintenance, 5(7)

Step 2: Add non-labour costs linked to own-account, including net operating surplus, 5(7).

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The Supply Approach Step 1 - detail

Software professionals

– Defined as ISCO88 213 if specific data is not available, 5(8).

– And found in all industries, not just Computer services, 5(9).

Labour costs based on compensation of employees; includes social contributions, 5(10).

Estimates of time spent on own-account activities, upper limit 50%, 5(11).

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The Supply Approach Step 2 - detail

Non Labour costs - Based on the ratio between labour costs and non-labour costs of the computer services industry, including net operating surplus, ensuring that no purchases of software, recorded as GFCF, are included, 5(12), 5(13).

Other Adjustments– Consistency in Income accounts, 5(14)

– Adjustments for any software previously recorded (incorrectly) as GFCF in SNA 68 accounts.

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Capital Consumption & Current Year

Capital Consumption

– Central range of 3-6 years, median 5, for asset lives.

– Similar depreciation patterns (straight line)

– Mortality function differences of less importance

– Important to consider impact of 1(7).

Current Year Estimation

– Various methods: Many assume growth in computer services industry can be used to proxy growth in own-account but evidence points to weak correlation.