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The Accounting Cycle
Peregrine Systems -- Or the Lack of Them


December 2004Peregrine Systems issued a fascinating 8K on October 15, 2004. It basically stated that the business enterprise does not have an internal control system, and therefore it cannot issue financial statements. Given that the last time Peregrine Systems issued a financial report the statements were false and misleading, this disclosure is a good thing.



According to company documents, the San Diego-based firm "develops and sells application software to help large global organizations manage and protect their technology resources." Interestingly, one of the major products is Consolidated Asset and Service Management software.

Around May 2002 the company joined the long list of entities with publicly known accounting scandals. That discovery triggered a stock market decline and an investigation by the SEC. Things became so bad that on September 22, 2002, Peregrine Systems declared corporate bankruptcy. It also fired and sued its previous auditor Arthur Andersen. As with so many other businesses, this tactic seems a desperate attempt to remove the culpability from management. This is not to say that Andersen does not share in the responsibility, as we shall see, but let’s never forget who initiated these prevarications.

The SEC issued its findings on June 30, 2003 in Litigation Release No. 18205A. Briefly, Peregrine Systems recognized revenue it should not have. Under the guise of selling software licenses to resellers, the firm actually made a number of side agreements that allowed these resellers not to pay Peregrine even one cent. In addition, it moved sales made in one quarter back to earlier quarters. Thirdly, Peregrine created financing arrangements with banks that exchanged receivables for cash and accounted for them as sales of the receivables. This treatment was improper -- the company should have regarded them as loans -- because the banks had recourse and some of the receivables were fakes. The SEC issued its usual cease and desist, to which the company says that it did nothing wrong but promises never to do it again.

In separate civil fraud cases, the SEC filed suits against the firm’s former senior treasury manager, the former chief financial officer, and the former vice president of sales. Later these individuals pled guilty to criminal offenses such as conspiracy and securities fraud. The investigations, however, continued. On October 6, 2004 the Department of Justice indicted eight other former executives of Peregrine Systems, including the former CEO Stephen Gardner. In addition, the DOJ indicted the former Andersen audit partner Daniel Stulac. Deputy Attorney General Comey commented, "When an outside auditor conspires with company officials to deceive the public, the potential to cause harm is vast, as the billions of dollars of losses involved in this case amply demonstrate."

In the Litigation Release cited earlier, the SEC directed Peregrine to comply with the rules regarding management’s report on internal controls (thereby putting into action Section 404 of the Sarbanes-Oxley Act for Peregrine). And for good reason! With the release of the 8K, the world now realizes how pathetic its internal controls are.

The report reads, "Our management has concluded that our internal control over financial reporting was not effective as of March 31, 2004, and is not effective as of the date of this report." It goes on to disclose that the accounting policies and procedures are not documented, general ledger accounts are not being reconciled on a timely basis, the financial reporting system is too complex and not integrated, and there are problems with the sales order processing system and with management reporting and analysis. There is insufficient segregation of duties and there are deficiencies in contract management. The firm lacks certain internal audit functions. In short, the company is still in a mess.

In part, these issues speak to the depths of the scandal. When accounting lies become embedded in the corporate culture, it takes a lot of things and a lot of time to make changes. In part, it makes one wonder how the firm is surviving at all. The firm makes and sells business software, including Consolidated Asset and Service Management software. Why would anybody believe that this software is worthwhile if the company cannot develop useful software systems to perform its own accounting functions? And in part, these concerns make one wonder why we should permit the firm to continue business. If the corporate culture is so infected with problems that they have not yet been solved and if they are selling a product that is suspect on its face, then maybe society is better off if Peregrine Systems is laid to rest.

J. EDWARD KETZ is accounting professor at The Pennsylvania State University. Dr. Ketz's teaching and research interests focus on financial accounting, accounting information systems, and accounting ethics. He is the author of Hidden Financial Risk, which explores the causes of recent accounting scandals, and columnist of The Accounting Cycle for SmartPros.com.

2004 SmartPros Ltd. All Rights Reserved.

Editorial content does not represent the opinions or beliefs of SmartPros Ltd.

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