What if... we knew the truth about company accounts?

Would the economy collapse if every accounting crime and misdemeanour came to light? Dale Vile thinks not...

With the Enron scandal and subsequent stories in the same vein, the issue of creative accounting in the corporate business world has consumed a good number of column inches. A question often discussed is whether such problems are exceptional or indicative of the general level of dubious commercial creativity that goes on around us.

The problem we have when considering this area is where we draw the line. If you delve deeply, you are likely to find that there has been an element of 'sailing close to the wind' involved in the rise of pretty much every business leader of worth. After all, it's that kind of behaviour that builds companies, makes money and creates jobs. Creativity is therefore the nature of the beast.

If we add to this the short-term mindset of many investors, we also have a set of external pressures that encourage companies to focus heavily on 'optimising' the story to shareholders. We know from experience that one poor financial indicator can cause investors to flee sending your stock price hurtling into the dirt. No wonder, then, that companies work very hard to produce a set of financials that will create investor confidence, even if they mask the realities of the underlying business.

As a result, practices intended to produce favourable accounts have become relatively commonplace, especially here in our beloved IT industry. In the early days, some of us old timers remember certain database companies having to repeatedly restate their financials. The cause here was the booking of revenue for software that had not yet been shipped. Indeed, some of the software sold at that time hadn't yet actually been fully developed. Some orders therefore amounted to no more than a loose statement of intention on the part of the customer that they would buy the software should it eventually become available.

So-called 'revenue recognition rules' are much more stringent today. For revenue to be booked and reported, there is a requirement for the product to be generally available and physically shipped. Still, however, you get the odd customer who is shipped a blank CD at the end of the quarter because the CD with the real product was gummed up in the internal works somewhere or couldn't be cut in time. Provided there is a FedEx slip saying a CD was put into the hands of a courier, that's good enough for most auditors - even though the customer service guys had to reship to an irate customer later.

But these are relative trivialities compared to some of the 'arrangements' I have come across over the years. One example is when a company I was working with lost a deal at the last minute when it seemed to be all but in the bag. The customer was a network services company in this case. We found out subsequently that our competitor had approached them with a creative proposition involving a cosy little reciprocal arrangement. This was along the lines of If you buy our software, we'll buy some of your networking stuff. This was all, of course, at premium rates to ensure that the reported revenue of each party was maximised.

One of my favourites is the old marketing funds scam. The customer wants to buy the product, but not at the price the seller wants to sell it at. So far so good - happens every day. Rather than offering a discount, however, the seller says: Tell you what, you buy at list price and we'll put a sum of money into a joint marketing fund that you will have complete control over. The amount invested in the fund is spookily similar to the level of discount the customer was looking for. Meanwhile, the top line of the seller has remained intact, as has their reputation in the market. They can now legitimately go to press claiming an order value that has in reality been inflated by 20-30 per cent, which on an eight or nine-figure deal, is quite substantial.

This kind of creativity works well when the main indicator being tracked is the revenue line. Other tricks come into play when trying to optimise the margin component or the perceived strength of a particular product line, for example by bundling several products together, then breaking out and allocating the revenues in favour of the preferred product for accounting purposes - Haven't we done well, this product was only released three months ago and already we have generated $10m in revenue from it.

None of these practices are quite as bad as some of the big league accounting creativity that has come to light recently in the US. But these are examples of the kind of things companies are getting up to every day in the IT industry.

We could throw our hands up in horror at this and be appalled at the way investors, customers and the media are sometimes misled. Such games can only be played for so long, however, before companies are found out. Just like an airbed with the bung in it, if you want one end to appear more inflated, you have to press down on the other end and distract people from the fact that you are doing so. The trick is finding more actual air to pump into the thing before someone realises that you have only redistributed the contents.

Sensible companies therefore reserve creative accounting for when it matters - perhaps when trying to optimise a particularly difficult end of quarter or trying to get a new product line off to a good start. One the whole, it is therefore unlikely to be as big a problem as people suspect in terms of overall economic activity. Nevertheless, there are a lot of business leaders out there who must hear the sound of bones rattling when another accounting scandal hits the headlines.

What are your thoughts? Post a Reader Comment below or email editorial@silicon.com to let us know.

**Dale Vile is service director at analyst house Quocirca. His C.V. boasts years at Nortel Networks, Bloor Research, SAP and Sybase and his job now involves working with vendors and users wanting to tap the business benefits of technology. For more information see: www.quocirca.com

Past columns:
What if... mobile operators fail the content challenge?
http://www.silicon.com/a56265
What if... we started spending again on IT?
http://www.silicon.com/a55389
What if... you needed an ROI case for everything?
http://www.silicon.com/a53188
What if... everyone always knew where you are?
http://www.silicon.com/a52368
What if... everyone always knew where you are?
http://www.silicon.com/a52368
What if... the sales and marketing director was put in charge of IT?
http://www.silicon.com/a51814
What if... 3G was available right now?
http://www.silicon.com/a51156