The Sales Shell Game

We've all seen the game where someone hides a something under one of three shells. The mark/ victim (!) bets on whether they can find the item as the shells are quickly moved around. Computer Associates (now called CA) provides a good example of what I'll call the Sales Shell Game. Here is some text from a 4/24/04 story from news.com:

"Computer Associates International's chief executive officer and chairman, Sanjay Kumar, stepped down ... after two years of investigations into the company's accounting practices.
The audit committee found that Computer Associates prematurely booked revenue in fiscal 2000 based on software license agreements that were actually recognized after the end of the quarter in which they were said to have been signed."

In the world of accounting manipulation, this activity is common. Image this: your a publicly traded company and under pressure to produce increasing earnings and sales. A critical time for you to report your results (to the entire free world!) is the end of each quarter. You've given stockholders and analysts a projection of your results. What happens if your actual results are below the estimate? Analysts may recommend selling your stock, shareholders panic and sell, the share price goes down, your income/ bonus and job are now at risk. What to do?

We'll, you'd love to maximize the amount of sales for the quarter. So you call a meeting of your sales staff. They deliver a message that several large sales are close, but won't get across the finish line by the end of the quarter. The next consideration is: What are our rules for recognizing a sale?

Beancounters love CONSISTENCY. In this case, our industry asks that management be consistent in how they report financials. That way, financial results are comparable quarter-to-quarter (it's apples to apples). Assume the rule is: We post the sales when goods are shipped. To meet the quarterly sales goal, you post sales on transactions that have been ordered but not shipped. In Computer Associates case, the software agreement sale did not meet the definition of a sale for the quarter when it was recognized.

Management's decision to do this has two bad outcomes. First, the treatment is not consistent and clearly may be driven by the pressure to meet financial projections. Second, management loses the ability to post the sale in the following quarter. Now, the next quarter's sales results are understated- not a smart way to start the new quarter!

Thought for The Day: 4/3rds of Americans do not understand fractions..........(Thanks, Dave)