Computer Associates International Inc. Case Study

To:     Head of Research Department

Re:     Analysis on the Stephen Richard’s Fraud Case[pic 1]

SUMMARY

Computer Associates International Inc. (CA) is the world’s leading commercial software developer. In 2001, several medias revealed that the CA has always used illegal means to exaggerate the sales revenue and profit data, and manipulated the company's earnings management. The former head of CA's worldwide sales, Stephen Richards, was sentenced to seven years in prison for the illegal extension of the fiscal quarter, delaying the closing date, manipulating the earnings management, and allowing contracts that may have been backdated. Stephen Richard’s actions seriously interfered with the judicial justice and GAAP principles. In order to protect his personal interests and the interests of company’s executive managers, he did nothing about the accounting fraud and even participated in this operation which allowed subordinates to obtain contracts after the quarter end. In the face of fierce marketing competition, his behavior was contrary to the GAAP principles and his action was illegal. From the company’s incentives and choices, we may know that the main cause of earnings management is that the interests of the executive management level and stakeholders are not consistent. In this report, we will present a detailed analysis of this accounting fraud and Richard’s actions in the following.

Manipulation

CA company's main operating incomes from the following aspects: (1) Provide customers with software access which can gain the license fee; (2) Provide technical support and software upgrade services to their customers; (3) Provide professional services to customers. In order to meet Wall Street's earnings expectations, maintain its stock’s high price and make executives managers gain from the stock option, CA company mainly used the manipulation of software license fees and extend the fiscal quarter to inflate its financial report and income statement.

Manipulation of Revenues

• Postpone the closing date and extend the accounting quarter. The CA played a trick on the closing date. They will account the last month of each quarter as 35 days, and those contracts that was signed in that period would be recognized in the current quarter, which would increase the current revenue.
• Backdate the contracts. CA will provide the pre-printed date of the contract to those customers who are willing to cooperate. The actual date of signing of the contract will be backdated to the end of the month in the last quarter period.
• Tamper the contract signing date. They will tamper the facsimile timestamp or alter the contract signing date before they provide the contract to the external auditor.
• In 2000 and 2001 fiscal year, CA confirmed a total revenue of $2.2 billion dollars, while in the previous accounting year, it confirmed the income of 561 million dollars in advance and false increased the profit of $333 million dollars.  FIND A TABLE FOR FISCAL DATA.

However, Richard knew exactly what was going on in the company’s internal manipulation strategy. He should be responsible for the things like the date of contract and current payments about the software license. His actions deeply affected the real accounting data and the real circumstance of the company. Shareholders and investors cannot evaluate the situation and marketing process of the company authentically.

GAAP Flexibility and Principles

According to the accusation of the prosecuting attorney, Richard’s actions didn’t follow the GAAP principles. If the CA achieved the same results through the GAAP flexibility, the consequence will be different. Because they might get the same financial results under the GAAP, then the auditors and the federal investigators will not find the evidences about the extension of the fiscal quarter, or the contract backdate.

Under the GAAP, the executive management level must choose a variety of policies and methods to make judgments in order to deal with the operating income and the preparation of financial reports. If Richard’s actions can achieve the reasonable financial results and choose the legal method to manipulate the earnings, then his actions will not be recognized as the illegal accounting fraud.

Internal and External Pressures

Richard used the wrong method to increase the operating income and revenue and affect the accounting department ‘s financial report in the fiscal quarter. The real reason why he did this is understandable. Due to the external marketing competition, the internal sales-driven-culture in the CA and Richard’s high position in the executives. He must increase the income and revenue during that downturn period, and he needed to think about the executives’ interests were related to the shareholders’ interests and company’s financial situation.