Accounting for taste?
With the channel recently hit by many unwelcome headlines relating to accounting malpractice, Sam Trendall asks how and why they happen, and how much they hurt the industry
HP and Autonomy are by no means the first channel firms to become embroiled in an unedifying accounting saga. In recent years a number of vendors, distributors and resellers have fallen foul of accounting malpractice and found themselves having to restate years of accounts and swallow big losses.
Many of the accounting fiascos to take place in recent years relate to the issue of revenue recognition, and the history of channel firms bringing forward sales to inflate quarterly or annual numbers is long and undistinguished.
And it could be argued that the channel's, shall we say, bullish sales culture is, at least in part, the cause of such behaviour. In the pressurised environment of the typical vendor or reseller sales floor - particularly on the last day of the month, quarter or year - it must be tempting to get a little creative with the numbers if it seems you may miss your target.
Nigel Cannings is better qualified than most to assess the cause and effect of accounting scandals in the IT sphere, having worked for many years as a lawyer advising major software vendors on a number of big acquisitions. He now runs his own software house: proactive compliance specialist Chase ITS.
He claimed that revenue-recognition fiddles will typically fall into two types: opportunist and calculated.
"There is the kind where it is the last day of the quarter and [a salesperson] knows that if they push something into the channel, [it is likely to] be sold on within a few days so they will take the revenue now - that is the wing-and-a-prayer approach. Then there is the wholesale fraud approach, where people push kit into the channel knowing it will come back in 90 days," he said.
"In my experience, it is not usually the accountants that are doing this - they are the ones who are spending their time trying to stop it. Is it a management thing? I suppose in some cases there is a nod and a wink [approach from senior managers]. Any CEO is only as good as their last quarter."
Cannings added that the only way to police such activity is to ensure the right internal procedures and attitudes are in place.
"The only way you can stop it is to make sure your sales processes are well integrated with your back office, and that you do not make people see accountants and lawyers as the enemy," he explained.
Robin Phillips, head of bid at Trustmarque, claimed that accounting scandals are "not helpful" to ethical and responsible channel players.
"It adds to the perception of IT [sales professionals] as latter-day snake-oil salesmen," he said.
Phillips admitted that staff at the York-based VAR "are no strangers to the last day of the quarter". But he suggested that the increased prevalence of annuity-based business models means that the days of channel salespeople desperately trying to book big-ticket, commission-laden deals at the last minute may be numbered.
"The paradigm is shifting as the channel embraces changing business models and moves more towards managed or cloud-based services," he said.
"We have people in our business who will have done half of their target at the start of the month; that gives them time to think a little bit more [about new opportunities]. But there are others who do not succeed here because they cannot change the way they think."
HP source?
Eddie Pacey, managing director of EP Credit Management and Consultancy, claimed that instances of malpractice can be characterised as "creative accounting" - within the constraints of GAAP regulations - or "aggressive accounting", deliberately designed to artificially inflate a company's value or standing. At smaller companies accounting foul-ups can often be the result of honest mistakes, he said.
"But [at larger companies] when it happens over a period of four or five years, you have to ask questions of the auditors; it should not just be a case of blaming the FD. The rest of the senior management has an overall degree of responsibility," added Pacey.
With so much invective and so many claims and counterclaims still being fired back and forth, it would be a folly to even hazard a guess as to where the blame lies in the HP-Autonomy farrago. But with the US giant having been forced to swallow an $8.8bn (£5.5bn) writedown little more than a year after making a $10bn acquisition, we can safely say that someone, somewhere, dropped the ball.
Nick Hood, head of external affairs at financial risk management and credit report specialist Company Watch, claimed that the world of corporate accounting is all too often ruled by "the law of the jungle", with senior executives more or less reporting the numbers as they wish.
"There is a very cosy relationship between companies and their auditors where the amount of scrutiny is limited," he added. "We need to deal with [problems] through international accounting standards."
Hood claimed that the HP-Autonomy imbroglio was indicative of a pandemic problem of a macho business culture and a lack of punitive measures for senior execs fuelling a world where acquirers routinely massively overpay for their buyout targets.
"They are driven by fantasy numbers; it is real back-of-a-fag-packet stuff," he said.
He encouraged the implementation of global accounting rules that would impose stricter sanctions on company profits and individual executive bonuses where companies swallow massive goodwill writedowns.
Legal expert Cannings was astonished at the scale of the alleged malpractice.
"It is still almost impossible to believe that you could go through a due diligence process and not spot the level of accounting irregularity that [HP] is suggesting took place," he said. "If you sent in a large accountancy firm, the first thing they would have done is restate the accounts under US accounting rules."
Everyone seems to be in agreement that the scandal has damaged the reputation of HP, and perhaps even that of the wider tech sphere. But Phillips from Trustmarque suggested that there may yet be some form of positive result.
"It may put big American vendor sharks off investing in other British start-ups; half of those acquisitions seem to fail," he said. "The last thing we want is to see is any more companies head off to America to die."
97-2 - the key legislation
It may not be the most familiar piece of industry jargon, but the AICPA Statement of Position (SOP) No. 97-2 will, according to those in the know, cause channel legal bods to wake up in cold sweats.
The legislation came into force in the US in 1997 after 12 years in the making. It codified accounting rules for revenue recognition at software companies. In short, to be booked onto the top line a sale had to meet four defined requirements: persuasive evidence of the existence of an arrangement; the occurrence of delivery of the first licence; the fee being fixed or determinable; and collectability being probable.
Legal and financial professionals from major US vendors will be all-too familiar with the ins and outs of all four of these.
Channel accounting scandals: A brief history
One of the highest-profile cases was that of software giant CA, which was found to have fiddled the numbers and kept accounts open to belatedly book additional revenue in 1999 and 2000. The scandal cost chief executive Sanjay Kumar not only his job, but also his freedom.
Nortel was another vendor giant to fall foul of accounting impropriety last decade, with the US Securities and Exchange Commission alleging that, from 2000 to 2003, the vendor had inflated the reserves on its balance sheet to bring earnings in line with market expectations. It would be somewhat reductive to draw a line between this and the company's ultimate demise, but the company's decline from the time the case was launched was brutally swift.
Autonomy is the latest vendor to stand accused of such malpractice, with the allegation being that the software firm stuffed the channel to artificially inflate its top line. Other vendors to have notably caught cooking the books in the last ten years include Lernout & Hauspie and Olympus.
And a little sleight of hand from the accounts department is by no means limited to big, multinational vendors. Danwood is one high-profile reseller to recently find itself in an accounting muddle. It emerged in recent weeks that the UK's largest print and copy VAR had uncovered "accounting weaknesses" dating back to FY05 in how it revenue from managed services contracts was recognised.
Accounts bods at the firm had been recognising hardware sales from services projects upfront in their entirety, rather than as and when kit was deployed over the course of the contract. The firm was forced to restate six years' worth of numbers and the restated accounts for FY10 impacted revenue to the tune of £16.26m, with operating profit reduced by more than £8.5m.
Services heavyweight Phoenix also found itself in an accounting pickle in recent months. The company slumped to a £60m operating loss in the first half of its 2013 fiscal year after discovering that profits at its former Servo business had been misstated for several years.
Accumuli is another channel player to suffer from the fallout of an accounting fiasco. Six months after buying security services player Boxing Orange, the buy-and-build outfit found out its new addition had understated liabilities to the tune of £500,000.
The most high-profile accounting saga in the distribution space was surely that of Bell Micro, which was delisted from the Nasdaq stock market in 2008 as accounts dating back to 2006 were restated as part of an ongoing review.