CEG GSB 703 Master Case Assignment #7 Adam Ohanesian Email: Adam.Ohanesian@nichols.

edu

Table of Contents
I. II. III. Introduction Background What CA tried to accomplish by changing business model a. How changes accomplished goal b. Risks IV. Change in accounting fit with new business model a. Conservative V. My feelings towards pro forma earnings numbers a. Disagreement b. Reasoning why VI. Action plan for Sanjay Kumar a. Revert back b. Benefits VII. VIII. CA after the case Conclusion/Recommendation

Computer Associates Inc. made a controversial change to its business model. It also changed its accounting principles to match its new business model. However, when the accountants revealed declining revenues and earnings, Computer Associates Inc. was challenged by investors. The issues faced by Computer Associates Inc. are that the company has changed it s business model and needs a change in accounting principles to coincide. Another issue is that the revenues and profits of Computer Associates Inc. are declining. The last issue, is that the change in accounting has been perceived to be fraudulent by investors who have challenged the management and has questioned their integrity. Despite the changes in financial reporting and changes in their business model, Computer Associates Inc. has been viewed in bad light. First, Computer Associates Inc. has come in for some harsh criticism in the financial press. For example from the New York Times As measured by standard accounting rules, Computer Associates sales have fallen almost two-thirds over the last six months. To cover that, the company has begun presenting its financial results in a way that confuses even the Wall Street analysts who follow it. Second, Computer Associates Inc. stock price has suffered. Third, it faces a proxy contest with a large dissident shareholder (Sam Wyley) who argues that The company has abused and alienated customers, employees and shareholders alike. Managements use of accounting gimmicks and its excessive compensation for lackluster performance have strained credibility with the financial community.

The objectives of this case analysis are to explore the changes made by the company, to try to understand why the company found it so difficult to get acceptance of the changes, and to recommend a course of action for the CEO, Sanjay Kumar.

1. What was Computer Associates trying to accomplish by the change in its business model? How did the changes accomplish these goals? What risks does the new model create? According to the case study, Computer Associates Inc. was trying to undertake a change in its business model. This was an attempt to follow a more conservative financial reporting method, and this led to improvement of its corporate governance. It tried to implement changes in its business model through a new compensation policy for sales representatives, a new revenue recognition policy, and the use of pro form numbers to inform the investors and external users of the present financial status of the company. The risks that the new model created was that conservative accounting would mean lower revenues and earnings. This would lead to criticism and doubts about the integrity of the company.

2. How does the change in accounting fit with the new business model? Since the change in accounting made the accounts more conservative, it fit the new business model of improved corporate governance. Since using conservative accounting rules the sales of Computer Associates Inc. have declined. In other words, the conservative accounting matched the new business model.

3. Do you agree with the companys decision to produce pro forma earnings numbers? I do not agree with the companys decision to produce pro forma earnings numbers. The reason for this is that if the company was using the conservative model, there was no need to use numbers that are not related to the business model. Further, pro forma earnings numbers should not have been used especially when the regular numbers showed a decline in the revenues and earnings compared to the previous year. In reality, the practice was called the 35-day month, in which employees inflated revenue by closing quarterly books a few days late.

4. What action plan would you recommend for Sanjay Kumar? The action plan I would recommend for Sanjay Kumar is to revert back to standard accounting rules. This will disclose the actual levels of decline in revenues and earnings. The point is that using creative accounting to cover up the declining sales over the past six months by presenting the financial results in such a way that confuses the Wall Street analysts is unethical and incorrect.

Since the case, Sanjay Kumar had to leave the position of chief executive officer and chairman. He was tainted by an accounting debacle. After he left, the company restated its earnings from 2000 and 2001 to show $2.2 billion in wrongly recorded revenue. Computer Associates Inc. was investigated by the SEC for lying about the timing of contracts to meet quarterly earnings targets. After Kumar left, Computer Associates Inc. stock started rising again. In conclusion, the change in the business model and the change in the accounting principles are ill advised steps taken by Computer Associates Inc. They must be truthful about its financial position and should use standard accounting rule to communicate its financial position. Hiding

poor performance behind confusing accounts is unethical and should be avoided at all costs. Hiding actual performance behind creative accounting gimmicks is not good corporate governance. Kumar should immediately publish accounts according to the standard methods so that the investors can compare the results with those of previous years and with those of other companies. Reference Material Sources Text book: Business Analysis & Valuation Using Financial Statements, Palepu & Healy, 2008, Thomson Sout-Western.

Berenson, Alex (2001, April 29). A Software Company Runs Out of Tricks; The Past May Haunt Computer Associates. The New York Times. Retrieved from www.nytimes.com http://www.nytimes.com/2001/04/29/business/a-software-company-runs-out-of-tricks-the-pastmay-haunt-computer-associates.html?src=pm