COURSE

EPPA4713 INTEGRATED CASE STUDY

SEMESTER 2 2022/2023

SET 3

TOPIC

CASE 4

NANOSYS’S CORPORATION BERHAD

LECTURER

PROF. DATO’ DR NORMAN MOHD SALEH

GROUP MEMBERS

GROUP NUMMA

NAME MATRIX NUMBER

1. NUR FASHAHAH SHAZNIN BINTI MAT OTHMAN A173528

2. UMY ASIAH BINTI YAHYA A173785

3. MUHAMMAD IRFAN BIN SAIFULAZMI A174136

4. MUHAMMAD FURQAN ANWAR BIN MOHD RAFIDI A174178

5. AUSATH WAFI RAIS AL A198049

 TABLE OF CONTENTS

1.0 INTRODUCTION 2
2.0 DISCUSSION 4
2.1 QUESTION 1 4
2.2 QUESTION 2 8
2.3 QUESTION 3 10
2.4 QUESTION 4 11
2.5 QUESTION 5 13
3.0 REFERENCES 15
4.0 APPENDIX 15

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1.0 INTRODUCTION

Nanosys is widely recognized as the leading software developer in the world, specializing
in the development and manufacturing of various products such as operating systems, web
browsers, and the Nanosys Office application suite. The company's reputation and success have
been extensively documented in numerous articles, books, documentaries, and even
made-for-television movies. One aspect that sets Nanosys apart is its cautious approach to
accounting decisions, particularly in relation to software development expenses and revenue
recognition. The company has a practice of capitalizing software development expenses and
subsequently amortizing them based on both current and projected revenue. This approach
ensures that the company maintains financial stability while also maximizing returns on its
investments. However, in 2016, Nanosys made significant changes to its revenue recognition
strategy in response to the integration of Internet technologies and increased support
commitments. This change involved deferring revenues from certain product sales, resulting in
an increase in unearned revenue. This strategic shift was aimed at managing analysts'
expectations and maintaining control over future revenue forecasts. To further safeguard against
potential market changes and consumer defaults, Nanosys maintained substantial cash and
short-term investment balances. This practice allowed the company to remain prepared and
resilient in the face of uncertainties. Despite its remarkable success, Nanosys recently came
under scrutiny from the Stock Exchange (SE). The SE launched an investigation into the
company's accounting practices, specifically focusing on the deferral of revenue and software
development costs. Nanosys remains committed to transparency and is actively cooperating with
the SE to address any concerns and ensure compliance with regulatory standards. Nanosys
Corporation Berhad has achieved remarkable financial success and expansion, boasting
impressive growth rates in both revenue and operating income. This has allowed the company to
dominate the operating systems market, solidifying its position as a leader in the industry.

The matter at hand pertains to the cost of software development, wherein Nanosys
currently expends all related expenses as they are incurred. However, the real standard dictates
that these costs should be capitalized and depreciated based on their useful life, aligning the
recognition of costs with the receipt of benefits. This discrepancy in Nanosys' revenue
recognition policy also has implications for potential tax obligations. Furthermore, the

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aforementioned policies have a collective impact on Nanosys' financial statements for the fiscal
years 2017, 2018, and 2019. Additionally, it is worth considering the advantages that Nanosys
may gain from adopting a more outwardly pessimistic outlook on its future prospects. Lastly, this
report delves into all the issues outlined above regarding Nanosys' operations.

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2.0 DISCUSSION

2.1 QUESTION 1

How did Nanosys’s software capitalization policy affect its financial statements? Ignore any
potential tax effects.

a. Assume that 60% of Nanosys research and development expenses were incurred after
technological feasibility was established, that the average product life was two years and
that the company begins amortizing software costs at the beginning of the following year.
Estimate the effect of capitalizing software costs on Nanosys’s fiscal 2017, 2018, and 2019
income statements and balance sheets.

2015 2016 2017 2018 2019

R&D expenses
860.00 1,326.00 1,863.00 2,601.00 2,970.00

60% expenses incurred after

technological feasibility 516.00 795.60 1,117.80 1,560.60 1,782.00

Amortization from previous year -

(30%) 258.00 397.80 558.90 780.30

Amortization from 2 years ago - -

(30%) 258.00 397.80 558.90

Total Amortization 655.80 956.70 1,339.20

Adjusted R&D recognised in 1,401.00 1,997.10 2,527.20

Income Statement

Increase in Profit 462.00 603.90 442.80

2015 2016 2017 2018 2019

R&D expenses
860.00 1,326.00 1,863.00 2,601.00 2,970.00

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 60% expenses incurred after
technological feasibility 516.00 795.60 1,117.80 1,560.60 1,782.00

Amortization from previous year

(30%) 258.00 397.80 558.90 780.30

Total Amortization 1,515.60 2,119.50 2,562.30

Based on the calculation above, Nanosys can increase their profit by RM 462 million, RM
603.90 million and RM 442.80 million in 2017, 2018 and 2019 respectively if they are
capitalizing software cost.

In capitalizing position, if they capitalise software cost Non-current Assets and Retained
Earnings will increase by RM 1,515.60 million, RM 2,119.50 million and RM 2,562.30 million
in fiscal year of 2017, 2018 and 2019 respectively.

b. Speculate why Nanosys chose to expense all software costs as incurred rather than
capitalizing a portion of these costs.

1. Nanoys thought that spending money on certain things was not necessary and chose to
pay for all software expenses as they happened.

The annual report states that research and development costs are recorded as
expenses when they occur, which supports the argument. The company is not
significantly affected by this standard and believes that these expenses are not substantial
enough to benefit from. This is because the company only determines amortization when
the expenses are capitalized.

2. Nanoys aims to reduce the tax burden on individuals or businesses by advocating for
lower tax payments to the government.

The government will impose taxes on a company's earnings. If the company does
not take advantage of its research and development costs, its pre-tax profit will be
reduced. By having a lower pre-tax profit, the company can decrease the amount of taxes

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it has to pay to the government. The saved funds can be used for activities that benefit the
company, such as paying dividends or improving system development.

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2.2 QUESTION 2

How did Nanosys’ revenue recognition policy affect its financial statements? Ignore
any potential tax effects.

a. Estimate the amount of revenue that Nanosys would have reported in each quarter
from 2016 through 2019 if Nanosys had not adopted its new revenue recognition policy
in 2016.
Prior to 2016, Nanosys adhered to a straightforward revenue recognition policy. Under
this policy, revenues were recorded upon the shipment of products to distributors and resellers,
the installation of corporate license programs by users, and the shipment of licensed products by
OEMs (original equipment manufacturers).

However, Nanosys has made significant adjustments to its revenue recognition policy
since the launch of its operating system in early 2016. As part of its commitment to fiscal 2016,
Nanosys has made a promise to seamlessly integrate its cutting-edge Internet technologies,
including the highly acclaimed Nanosys Internet Explorer web browser, into its existing product
offerings, all at no additional cost to its valued customers. This strategic decision, coupled with
the company's ongoing commitment to customer support and product enhancements, has led
Nanosys to adopt a revenue recognition approach that allocates approximately 20% of income
from the Nano95 operating system over the entire product lifecycle, which is currently projected
to span two years. Similarly, the revenue from Nano97 is recognized proportionally over an
estimated 18-month product lifecycle. This new recognition policy ensures that 80% of the
revenue is recognized upon shipment, while the remaining 20% is recognized gradually
throughout the product's lifespan.

(A) (B) (C) (B+C)

Unearned Revenue Difference Adjusted
Revenue Balance (RM’000) (RM’000) Revenue
(RM’000) (RM’000)

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 2016

Q4 560

560

2017

Q1 651 2,405 91 2,496

Q2 1,013 2,808 362 3,170

Q3 1,285 3,365 272 3,637

Q4 1,418 3,358 133 3,491

1,418 11,936 858 12,794

2018

Q1 1,672 3,334 254 3,588

Q2 2,038 3,792 366 4,158

Q3 2,463 3,984 425 4,409

Q4 2,888 4,152 425 4,577

2,888 15,262 1,470 16,732

2019

Q1 3,133 4,193 245 4,438

Q2 3,552 5,195 419 5,614

Q3 4,195 4,595 643 5,238

Q4 4,239 5,764 44 5,808

4,239 19,747 1,351 21,098

Based on the data presented in Table 3, the revenue figures for 2017, 2018, and 2019
stand at an impressive RM11,936 million, RM15,262 million, and RM19,747 million

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respectively. However, upon making necessary adjustments, the revenue increased significantly
to RM12,794 million for 2017, RM16,732 million for 2018, and RM21,098 million for 2019.
These revised figures clearly indicate that had Nanosys not implemented its new revenue
recognition policy in 2016, the company would have achieved even higher revenues compared to
those achieved under the new policy.

b. Speculate why Nanosys decided to defer a portion of its revenues in fiscal 2016.

The case highlights the importance of implicit commitment in the software industry.
Software providers and developers are generally expected to fulfill certain obligations, which
may vary depending on factors such as the specific context, type of software, and the relationship
between the parties involved. In the case of Nanosys, they have adopted a more conservative
accounting policy, leading to changes in the recognition of revenue for their product sales. As a
result, Nanosys is required to comply with the accounting standard for revenue generated from
upgrades, add-ons, and other improvements. Under this policy, customers only need to make a
one-time payment to purchase the software, and any revenue generated from subsequent
upgrades or improvements will be provided to them free of charge.

Furthermore, Nanosys has implemented a strategy known as cookie jar reserves, which
involves setting aside funds or provisions that can be utilized to artificially enhance future
earnings or mitigate potential losses. The purpose behind utilizing cookie jar reserves is to
smooth out fluctuations in reported earnings and present a more consistent and stable financial
performance. This practice allows the company to safeguard against potential losses that may
occur in the future. Although some businesses have found value in utilizing cookie jar reserves
as a means to manage income volatility and provide reassurance to investors, it is generally
considered unethical. This practice has the potential to deceive investors and stakeholders by
distorting the true financial performance and overall well-being of a company. In the case of
Nanosys, for example, in the fiscal year of 2016, they may allocate approximately 20% of their
operating system's revenue to reserves.

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2.3 QUESTION 3

What was the overall impact of these two policies on Nanosys’s fiscal 2017, 2018, and 2019
financial statements?

Adopting a software capitalization policy leads to adding amortization expenses. These expenses
represent the systematic allocation of the capitalized software costs over time. Other than that,
the research and development (R&D) expenses associated with software development will likely
decrease. This occurs because the costs incurred during the development process are now being
capitalized and amortized over time. As a result, R&D expenses, a significant component of total
expenses, will be reduced. This further contributes to the potential decrease in total expenses and
the subsequent increase in operating income and net income under the new policy. On the other
hand, not adopting a revenue recognition policy can increase reported revenue for the
corresponding fiscal years. This means revenue may be recognized earlier or different than when
a standard revenue recognition policy is followed. The increase in reported revenue can affect
various aspects of the income statement. For instance, the cost of goods sold (COGS) might also
increase proportionally with the higher revenue. This occurs because more goods are being sold,
requiring additional direct costs for production. Operating expenses such as selling, general, and
administrative expenses might also increase as sales volume rises.

Adoption of a software capitalization policy increases the value of non-current assets (software
development) and intangible assets on the balance sheet, reflecting the company's investment in
software development and ensuring transparency. Additionally, Retained earnings, part of
shareholders' equity, increase due to the deferral and recognition of expenses over time, resulting
in a higher debt-to-equity ratio. However, Not adopting a revenue recognition policy can lead to
a decrease in cash and short-term investments on the balance sheet, as revenue is recognized
earlier or differently, resulting in earlier cash receipt and investment.This may also eliminate
unearned revenue on the balance sheet, as all revenue is considered earned.

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2.4 QUESTION 4

In your opinion, did Nanosys provide its analysts with information that was intentionally
overly pessimistic? Are there any benefits to the company for being outwardly pessimistic
about its future prospects?

Based on the information provided, there is no indication that Nanosys intentionally

provided overly pessimistic information to its analysts. First, Nanosys's financial performance in
the years leading up to the release of the pessimistic information was actually quite good. In
2015, the company's revenue grew by 25%, and its net income grew by 40%. This suggests that
Nanosys was not facing any major financial challenges at the time. Second, the pessimistic
information was released just days before Nanosys was scheduled to release its financial results
for the fourth quarter of 2015. This timing suggests that Nanosys may have been trying to
artificially depress the price of its stock in order to make its financial results look better.

Finally, the pessimistic information was not supported by any concrete evidence.
Nanosys simply stated that it was "facing challenges" and that its "future prospects were
uncertain." However, it did not provide any details about these challenges or why it believed its
future prospects were uncertain. Based on these facts, it is possible that Nanosys intentionally
provided overly pessimistic information to its analysts. However, it is also possible that the
company was simply being cautious and that the information was not intended to be misleading
In conclusion, there is no clear evidence that Nanosys intentionally provided overly pessimistic
information to its analysts. However, the timing of the release of the information and the lack of
supporting evidence suggest that this may have been the case.

There are a few potential benefits to a company being outwardly pessimistic about its
future prospects such as it can help to manage expectations. If a company is honest about the
challenges it faces, it can help to prevent investors and customers from being disappointed if
things don't go according to plan. This can help to build trust and credibility with stakeholders.
Next, it can motivate employees, for example if employees know that the company is facing
tough times, they may be more motivated to work hard and come up with creative solutions. This
can help the company to weather the storm and emerge stronger on the other side. It also can
attract investors who are looking for undervalued opportunities. Some investors are attracted to

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companies that are perceived as being undervalued. If a company is pessimistic about its future
prospects, it may be seen as a good opportunity for investors who are looking for a bargain.

Ultimately, whether or not there are benefits to being outwardly pessimistic depends on
the specific circumstances of the company. If a company is facing serious challenges, it may be
helpful to be honest about those challenges. However, if a company is simply trying to manage
expectations, it may be better to be more optimistic. In the case of Nanosys Corporation Berhad,
the company has been struggling financially for several years. In 2022, the company reported a
net loss of RM25.4 million. The company's share price has also been declining steadily. In light
of these challenges, it is understandable why Nanosys would be pessimistic about its future
prospects. However, there are also some potential benefits to Nanosys being outwardly
pessimistic. For example, it could help to manage expectations among investors and customers.
It could also motivate employees to work harder to turn things around. Ultimately, whether or
not there are benefits to Nanosys being outwardly pessimistic will depend on how the company
manages its communication with stakeholders.

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2.5 QUESTION 5

Why was SE concerned about it?

The Stock Exchange (SE) is looking into concerns that Nanosys altered reserve accounts to
smooth out claimed earnings. The SE was concerned about the manipulation because it would
lead investors to feel that the company is performing better than it actually is, which could lead
to inflated stock prices. Furthermore, if the SE found evidence of unethical financial reporting, it
may undermine investor confidence in the company and the stock market as a whole. Due to this,
trading activity and liquidity may decline, which would ultimately be detrimental to investors
and the economy as a whole. The SE also has a responsibility to ensure that all companies who
trade on the exchange follow accounting standards and regulations in order to maintain a fair and
open market. The SE may therefore investigate any potential violations of these laws and
regulations. Besides that, the SE may have been concerned about the change in Nanosys' revenue
recognition strategy. Following the standard, MFRS 15 provides guidelines on how to determine
when to recognize revenue and how to measure the amount of revenue to be recognized. The
standard applies to all types of revenue-generating contracts, including sales of goods, provision
of services, and construction contracts.

On stock markets, securities are exchanged fairly and in a timely way. Any significant changes to
a company's revenue recognition technique could change the perception of its financial health
and future prospects, which could lead to market instability or unfair trading practices. It would
be ideal to prevent insider trading and market manipulation based on incomplete or misleading
financial information. Companies that are listed on stock exchanges have to comply with strict
disclosure and listing requirements. It may be necessary to properly declare and comply with
exchange regulations any changes to accounting standards, such as those pertaining to revenue
recognition. A worry would be ensuring that Nanosys adhered to the crucial listing requirements
and correctly informed the market about the policy change.

In addition, Nanosys Corporation Berhad failed to file annual reports. Nanosys failed to file its
annual reports for the financial and to pay annual listing fees years ended 2016, 2017, and 2018.
This is a serious breach of the SE's listing requirements, which require all listed companies to file
their annual reports and to pay their annual listing fees on time. Questionable financial

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transactions. The SE was also concerned about a number of questionable financial transactions
that Nanosys had entered into. For example, Nanosys had loaned large sums of money to its
directors and controlling shareholders. The SE was concerned that these loans may have been
used to enrich the directors and controlling shareholders at the expense of Nanosys's other
shareholders. This made it difficult for investors to assess the risks associated with investing in
Nanosys. As a result of these concerns, the SE placed Nanosys on a trading halt in 2019. The
trading halt was lifted in 2020, but Nanosys remains under the SE's close scrutiny. The SE's
concerns about Nanosys are a reminder of the importance of transparency and accountability for
listed companies. When companies fail to comply with the SE's listing requirements, it can have
serious consequences for investors.

Next, SE may be concerned about the transparency and comparability of financial statements
across different companies in the industry. The strategy used by Nanosys may make it difficult
for investors and analysts to compare financial performance and accurately assess the company's
competitiveness if other businesses in the sector capitalized and amortized software development
costs in accordance with the established accounting standards. Investors and stakeholders rely on
accurate financial information to make knowledgeable decisions and evaluate the financial health
of the organization. Capitalize and amortize software development expenditures could give a
more accurate view of Nanosys' profitability, return on investment, and overall financial viability
if such costs are important to the company's operations. Expensing these expenditures might not
accurately reflect their long-term value, and the stock market would worry that doing so might
make it more difficult to analyze investments. Financial reporting must comply with accounting
rules, such as the Generally Accepted Accounting Principles (GAAP) indicated in the statement.
The stock exchange might be worried because Nanosys's practise of deducting software
development costs as they are incurred might not be in accordance with these accounting
requirements.

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3.0 REFERENCES

Girsch, M. (2022, August 5). Deferred Revenue: How to Recognize It Properly. The Motley
Fool. Retrieved June 9, 2023, from
https://www.fool.com/the-ascent/smallbusiness/accounting/articles/deferred-revenue/

Khartit, K. (n.d.). Income Smoothing: Definition, Legality, Process, and Example. Investopedia.
Retrieved June 9, 2023, from https://www.investopedia.com/terms/i/income-smoothing.asp

4.0 APPENDIX

Kindly refer to the Microsoft Excel sheet attached for the calculation performed.

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