A string of recent scandals, involving companies as diverse as WorldCom and Peregrine Systems, have underlined how the technology sector, with its fast growth and complexity, is peculiarly vulnerable to lax and inaccurate financial reporting practices.

Questionable bookkeeping techniques employed by a worryingly large number of high-tech companies include : trickling back restructuring costs; trickling back sell-off benefits; channel stuffing; ‘hollow swaps’; abuse of ‘related transactions’; and hiding of profits. So-called pro forma reporting is also used liberally.

Now, analysts at Credit Suisse First Boston (CSFB) have introduced a formal grading system in order to establish the quality of European software companies’ accounts. CSFB began its scrutiny of the industry with five familiar names: Business Objects, the French business intelligence tools vendor; Dassault Systemes, France’s engineering software specialist; Misys and Sage, the UK financial applications vendors, and SAP, the German business applications giant.

The analysts based their assessment on 10 particular issues. No single company was given perfect marks.

For example, SAP scores highly on the way it accounts for its venture investments but does less well on its use of pro forma adjustments. Dassault Systemes earns plaudits for its revenue-recognition policies but is marked down on its treatment of stock options. And Misys is congratulated on its segment reporting, but criticised for the way it accounts for acquisitions.

What about US companies? If the Securities and Exchange Commission (SEC) has its way, every company will soon be getting an ‘A’ grade. It recently began a major set of reforms covering the behaviour of investment banks, tightening auditing practices and setting new standards for the liability of CEOs (see analysis section later in this issue).

In a meeting in July 2002, the SEC told auditors that they must ‘red flag’ a whole range of business and accounting practices that most technology companies would recently have considered normal practice. These include :

• End of quarter discounts (which may indicate future revenues lost)
• Bill and hold. This means keeping them in the warehouse until they are ‘called off’
• Poor or delayed data collection from the field (meaning problems are not discovered until later)
• Big changes in forecasts without material events occurring
• Earnings reports that repeatedly come out suspiciously close to, or above, market expectations
• Poor internal controls

It remains to be seen, however, how diligently auditors will raise – and act upon – their concerns.