National Accounts Experts’ Meeting October 2002 Economic Analysis and Statistics Division Directorate for Science, Technology and Industry OECD Software Task Force Final Report Nadim Ahmad

08 October Software Task Force  Background  Definitions and Accounting Framework  Trade  Deflators  Business Accounting; implications  The Supply Approach & Own-Account Estimation  Capital Consumption, Current Yr Estimation

08 October Background

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

08 October Definitions, Concepts, Classifications Definitions Concepts & Transactions Concordance Classifications

08 October 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.

08 October 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

08 October 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.”

08 October 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.

08 October 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.

08 October 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.

08 October 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.

08 October 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

08 October 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.

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

08 October 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 , USIC 7372

08 October 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 , 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 , USIC 7371 –databases where exclusive ownership rights are transferred. CPA 72.4, USIC 7372

08 October 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.

08 October 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 , , , (ex

08 October Deflation

08 October

08 October 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).

08 October 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.

08 October 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.

08 October 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)

08 October 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).

08 October 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).

08 October The Supply Approach Step 1 - detail Software professionals –Defined as ISCO 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).

08 October 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.

08 October 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.