Assignment 1 – ACC557 – Peregrine Systems Accounting Scandal Heather Glover
Peregrine Systems, Inc. was an enterprise software company that was founded in 1981 and sold enterprise asset management, change management, and ITIL-based IT service management software. Following an accounting scandal and bankruptcy in 2003, Peregrine was acquired by Hewlett-Packard in 2005.HP now markets the Peregrine products as part of its IT Service Management solutions, within the HP Software Division portfolio. Wall Street's demand for high growth motivated Peregrine Systems' executives, to fraudulently inflate revenues and stock prices. Peregrine apparently filed materially incorrect financial statements with the commission for 11 consecutive quarters. A member of Peregrine's sales team admitted to meeting regularly with senior management near the end of the quarter to determine how much revenue was needed to exceed Wall Street's expectations. The primary fraud committed by Peregrine was done by inflating revenue by booking revenue when sales never occurred. By recognizing revenue from sales that never occurred, the accounts receivable balance and net income were fraudulently overstated; the accounts receivable would never be collected, because the merchandise was never sold. To cover up their high, outstanding, accounts receivable balance as a result of booking sales that did not occur, Peregrine fraudulently engaged in financial agreements with banks. Evidently, Peregrine Systems increased its revenues by pressuring distributors and resellers to build up their inventories. Through secret side or oral agreements Peregrine distributors and resellers were not obligated to pay Peregrine for their software inventories. This conduct obviously became a problem. If they could not sell Peregrine's software, they would receive their money back. According to GAAP, revenue recognition on the sale of software requires evidence that an arrangement must exist, delivery must have occurred, vendor's fees must be fixed or determinable, and collectability must be probable before recognizing revenue. Peregrine falsely recorded this transfer of inventory to distributors and resellers as revenue. Peregrine officers, sales personnel, and channel partners knew through secret oral or written side agreements, that the channel partners were not obligated to pay Peregrine, but that Peregrine would later negotiate sales to end-users and arrange for the payment to `flow through' them; the channel partners had 30 days or more to back out of the software license contracts; or if the channel partners were unable to resell Peregrine's software licenses, they could invoice Peregrine for `services' in a dollar amount equal to what they had not resold." Peregrine falsely recorded as much as $225 million by falsely recognizing revenue in this way and recording it as a "non-substantial transaction," which was in violation of GAAP revenue recognition criteria for software sales. By violating GAAP revenue recognition criteria, revenues and stockholders' equity was overstated, and liabilities were understated. As a result of recognizing revenue without actually making a sale, Peregrine accumulated a large number of receivables on its balance sheet that would not or could not be paid. To remove the receivables from the balance sheet, to avoid suspicion, and to lower the days' sales outstanding number, Peregrine assigned almost $141.6 million of its accounts receivable balance to a bank. However, they reported the assigned receivables as a factoring agreement. In an assignment, the borrowing company (Peregrine) usually retains ownership of the assigned accounts, incurs any bad debts, collects the amounts due from customers, and uses these funds to repay the bank. In an assignment, the accounts receivable are not eliminated from the balance sheet; a liability is created, and the receivables are sold with recourse. This recourse...
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