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Notes on Major Case 3
MicroStrategy
Ethical Issues:
This case centers revenue recognition at MicroStrategy in 1997 to 1999. It provides an
opportunity to discuss revenue recognition in the high tech industry and how to recognize
revenue when the sales contract covers many products, prized as one, and when the products are
very different with different deliverable methods and timeline. The case presents a common way
of manipulating earnings by holding open end-of-quarter and end-of-year time periods until the
conditions have been met to justify recording revenue in the desired period.
Revenue manipulation techniques violate GAAP and present cut-off issues for auditors that
should be diligent and examine documentation to support the recording of revenue in one period
or another. In that regard, a healthy dose of skepticism helps an auditor to exercise the degree of
objectivity and care required in an under conducted under GAAS.
Questions
1. Evaluate the accounting decisions made by MicroStrategy from an earnings
management perspective. What was the company trying to accomplish through the
use of these accounting techniques? How did its decisions lead the company down
the proverbial “ethical slippery slope?”
MicroStrategy was engaging in earnings management in its revenue recognition practices.
Material revenue was booked the last day of the quarter; contracts were back dated in order to
meet earnings expectations ; multiple-element contracts were accounted for as software license
fee contracts; and a swap of software was accounted for as a sale. The pressure to make the
numbers led the company to engage in Schilit’s shenanigan number 1: recording revenue too
MicroStrategy was managing earnings. Its actions were deliberate and an attempt to make the
company look like it was doing better than it really was on a quarter-by-quarter basis and year-
2. What motivated MicroStrategy and its management to engage in this fraud? Use the
pressure and incentive side of the fraud triangle to help in answering the question.
How would you characterize the company’s actions in this regard with respect to
ethical behavior, including a consideration of Kohlberg’s stages of moral
development?
MicroStrategy and its management may have driven by greed. However, pressure to achieve
financial analysts’ estimates of earnings seems to have been the driving force behind the decision
to “cook the books,” or the pressure or incentives to commit fraud , the first side of the fraud
triangle . The second side of the fraud triangle connects the pressure or incentive to commit fraud
with the opportunity to carry out the act. This side of the triangle may be seen in the backdating
3. Why is independence considered to be the bedrock of auditor responsibilities? Do
you believe PwC and its professionals violated independence requirements in the
AICPA Code of Professional Conduct? Why or why not? Include in your discussion
any threats to independence that existed.
If the auditor is not independent, the audit report has little meaning to investors and trust at stake.
Independence establishes the standard that the auditors should not allow threats to their
The users of financial statements rely upon the financial information provided the company. The
goals of the company may run somewhat counter to those of the users of financial statements.
This creates a need for independent auditors. These auditors need to be individuals that are
PwC did not approach the audit of MicroStrategy with sufficient skepticism and failed to
obtain relevant evidence to support revenue recognition and demonstrated a lack of due care in
carrying out professional responsibilities. Threats to independence can arise in situations where
