BACKGROUND
Computer Associates (CA) is an independent software company. They provide network software, PC software, database and banking applications. Under a typical licensing arrangement, customers agree to pay a license fee to CA for the right to use software for a period of time. Under the old business model it was a period of three to ten years. Under the new model it is a time frame of one month to a maximum of three years. Under the old plan, licenses fees were reported as revenue once a customer signed a contract.
So if a customer signed a ten-year contract then CA would report all the revenue from the license fee in that first year. Under the new plan the license fee is spread over the term of the contract. Maintenance fees in both the old in new plan are recognized over the maintenance period. One of the main problems with the old plan was the way that commissions were calculated. Commissions were calculated quarterly and they were based on the present value of the annual license fees or contracts sold. So sales representatives would try to push contracts towards the end of the quarter.
Customers knew how the commissions were calculated and would wait until the last month of the quarter to purchase so that they could receive a larger discount. After the contract was signed the sales representatives would not follow up with the customers to make sure that they were happy they would just move onto the next customer. Under the new business model it is based around customer service. Computer Associates shortened the length of a contract period so that the sales representative would stay in contact with the customers.
CA also changed the method of compensating the sales representatives; under the new plan their commission was based on not only what they sold but also their level on customer service. In also trying to revamp customer service CA added a customer relation’s organization and hired 625 new staff to run it. Because of the new way of reporting revenue there was a drastic change in the Financial Statements. Investors were also confused and skeptical of the “pro forma” numbers the company was disclosing. The investors were told the pro forma numbers were a way to help investors compare the past with the future.
This raised suspicions with shareholders and investors. Sanjay Kumar was challenged several times about the new way of accounting. Eventually, not noted in the book, Kumar was sentenced to prison for is massive accounting fraud.
CASE QUESTIONS AND DISCUSSION
What was Computer Associates trying to accomplish by the change in business model? How did the changes accomplish these goals? What risks does the new model create? By changing the business model Computer Associates was trying to keep customers and provide them better customer service.
In the past sales representatives would not follow up with existing customers they would only go after new ones. It would frustrate the present customers. The sales reps would not take the time to find the best fitting program also for the customers. They would push the customers thru just so they could make the commission on the sale. The customers also knew how the commissions were calculated and would use it to their advantage. So they would wait until the last month of the quarter and “strike a deal” with the sales representatives. Under the new plan the sales representatives were given monthly sales quotas.
Commission rates were variable they would now be on somewhat of a scale: Highest rates- Sales of new products to new customers. Lower rates- Sales of new products to existing customers. Lowest rates- Extension of a license for an existing customer. In addition CA was also going to improve customer service, so the sales reps would now have 20% of commissions based on customer satisfaction. The company also hired 625 new staff for its customer relation’s organization, so that customers could have a single point of contact for all their needs. With the addition of all these employees CA increased its payroll expenses. To some that is a risk, they are reorganizing and adding additional liabilities without yet adding any more assets.
How does the change in accounting fit with the new business model? Under the new model they were also trying to provide more accurate Financial Statements, so CA changed its method of reporting revenues. In the past they would record revenue at the time of the contract, no matter how long the contract all the revenue would be booked in that quarter. Under the new plan the revenues would be recognized ratably over the life of the contract.
The risk with presenting a new way of accounting is it is difficult to compare the past and the future. Also with such huge differences in revenue it raises suspension if things were done right in the past. One of the biggest discrepancies was that in 2000, before the change, CA reported a profit of $696 million; now after the change in 2001 the company reported a loss of $591 million. CA’s reasoning for the change was that it related to the change in reporting the license-fees revenues. But this reasoning was still not acceptable with some shareholders and it raised suspicion.
Do you agree with the company’s decision to produce pro forma earnings numbers? I think by CA’S decision to produce pro forma earnings numbers they were just opening the door to tons of critism and accusations. Pro forma earnings numbers have no real rules; the company can essentially pick and choose what they want to be in those Financial Statements. The SEC is also suspicious of companies whom use this type of reporting. I do understand though that the company was trying to provide the shareholders comparable information so that they could analyze the company.
Mostly because of the large variance in revenue for 2000 vs. 2001, but the pro forma reporting is too subjective that it is really not a reliable source of reporting. To me CA was trying to come up with a way of just pacifying the questions from the shareholders by presenting comparable Pro Forma Numbers. CA was hoping that by giving them the Financials the problems would go away. 4. What action plan would you recommend for Sanjay Kumar? When I first read this case I thought to myself, “Sanjay Kumar is trying to do the right thing for Computer Associates, Mr. Wyly is just looking for a fight. ”
Mr. Wyly would issue challenge after challenge it almost seemed like he was just upset over the sale of him company to CA. My originally plan of action for Sanjay Kumar was to put all the suspension of wrong doings to rest but allowing the shareholders to pick an auditing firm to come in and analysis all the accounting books. But then I started doing research on the internet and realized that Sanjay Kumar pled guilty to obstruction of justice and securities fraud charges on April 24, 2006.
On November 2, 2006, it was reported that he was sentenced to 12 years in prison and fined $8 million for his role in a massive accounting fraud at Computer Associates. I am thinking that Sanjay Kumar would not have liked my advice because it would had uncovered just what Mr. Wyly was accusing him of.
CONCLUSION
In conclusion, I think what the board was trying to accomplish by changing the business model was a great idea. I believe by producing financial statements were the revenue is recorded on a month of service basis rather than a lump sum at the time of the contract the Financials are more accurate.
By changing the Financials in this direction the shareholders and investors have a clearer picture of what the monthly or quarterly statements really do look like. As by changing the model to be driven by customer service rather than just revenue the company is projecting to its customers that there business is not only about making money by also about the customers which is the foundation of there business. I think the idea was a good one but got misguided some by the board and by Sanjay Kumar. The idea of producing Pro Forma earnings numbers was somewhat a good idea.
They were trying to give the shareholders financial information that was comparable. The huge problem with those is that they can be misguiding. The Company can pick and choose what they want to present there is no regulations for them. This case to me also shows that in business you really have to have top-level executives that you can trust and ones that are ethical. In the case of Sanjay Kumar some bad decisions that were ultimately made by him were detrimental to the company.
REFERENCES
- Palepu, K. , & Healy,P. (2008). Business Analysis & Valuation Using Financial Statements, (4thed. Mason, OH: Thomson.
- CNET (November 2,2006) Former CA exec Kumar sentenced to 12 years Web Site: http://news. cnet. com/Former-CA-exec-Kumar-sentenced-to-12-years/2100-1014_3-6131943. html? tag=lia;rcol
- All Things Digital (November 4,2008) Sanjay Kumar Goes to White Castle Prison Web Site: http://digitaldaily. allthingsd. com/20080904/sanjay-kumar-goes-to-white-castle-prison/
- Wikipedia (Various dates): Sanjay Kumar, Web Site: www. wikipedia. org- http://en. wikipedia. org/wiki/Sanjay_Kumar
- Investopedia :Understanding Pro-Forma Earnings Web Site: http://investopedia. com/articles/01/103101. asp
