A Letter from Prison

1. Problem Statement

Diversity in accounting principles creates for a manager the possibility to play within a grey zone with widespread boarders. It is questionable to what extend company's financial statements are manipulated by management decision processes that are influenced by expectations set by top management levels and outside parties.

2. Analysis

2.1. Computer Associates International

Computer Associates International Inc. (CA) is an IT management software and solutions company with expertise across all IT environments. About 95% of Fortune 500 companies are using CA software. The company allocates around 80% of their revenues to the licensing fee. Based on GAAP, revenues from software licensing were recognized once the following three conditions were met:

* The contract was signed

* The software was delivered

* The payment was reasonable assured

As soon these three revenue recognition criteria were met CA recorded the entire present value of the licensing contract in the current quarter.

The management set high internal targets for each quarter. This "sales-driven culture" put sales associates under immense pressure. Furthermore high commissions were paid to sales associates as well as executives if they hit or exceeded these targets whereby a trickle down effect of pressure was formed. For these reasons CA was among the most aggressive in its pursuit of goals. In addition CA management was known for their aggressive accounting practices to boost earnings, though, the presented financial statements were in all material aspects in accordance with GAAP.

Nevertheless in July 2003 federal investigators (DOJ & SEC) articulated discontent with CA's accounting procedures. Internal investigations took place, which provided sufficient evidence of the backdating of some contracts. Even though the investigation committee was not able to find any indication that the revenues and cash flows related with these deals were not genuine they should have been recognized in the quarter in which the contract was signed. Corollary: three executives were forced to resign. The next step for the prosecutors was to find out who else was involved in the backdating.