CASE 1.10
GEMSTAR-TV GUIDE INTERNATIONAL, INC.
Synopsis
Born in war-torn China in 1948, Henry Yuen, known then as Che-Chuen, was forced to flee
that country with his family. After Communist forces took over China, large numbers of supposed
International, Inc. (GTGI).
Yuen and many other industry insiders expected that interactive TV would be the wave of the
future in the television industry. Since electronic programming technology would be indispensable
to creating interactive TV services, many securities analysts believed that GTGI would rack up huge
profits as those services proliferated. Unfortunately for Yuen, to date interactive TV has been a bust.
To conceal the discouraging financial performance of GTGI’s over–hyped “Interactive
with a $10 million fine.
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Gemstar-TV Guide International, Inc. — Key Facts
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1. In 1988, Henry Yuen and a close friend developed VCR Plus, a new technology for
programming VCRs; this technology would become the flagship product of Gemstar Development
Corporation, a company that the two friends created.
2. During the late 1990s, Gemstar acquired nearly 100 patents; these patents allowed the company
3. In 2000, Gemstar acquired TV Guide International, creating GTGI (Gemstar-TV Guide
4. Yuen, GTGI’s CEO, focused his energies on promoting the company’s new Interactive Platform
5. Murdoch, who was the leader of the GTGI faction made up of former TV Guide executives,
6. Shortly after the 2000 merger that created GTGI, Yuen and several of his subordinates began
7. After GTGI’s accounting fraud was uncovered by the SEC, the company was forced to restate
its prior financial statements.
9. The SEC charged that KPMG was guilty of “repeated audit failures” during its GTGI audits.
10. Specifically, the SEC charged that GTGI’s KPMG auditors had failed to uncover abusive
Instructional Objectives
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2. To identify fraudulent methods commonly used to overstate revenues.
Suggestions for Use
This is a case that revolves around a small sliver of everyday life in American culture, namely,
the ubiquitous television scroll that many of us check numerous times per day to find a flick,
sporting event, or random television program to while away a few mindless minutes . . . or hours.
Suggested Solutions to Case Questions
1. We are all familiar with the basic revenue recognition rule: revenue should generally be
recognized when it is realized or realizable and when it is earned. Although seemingly simple, that
rule can be difficult to apply, particularly in rapidly evolving high-tech industries. Revenue
recognition within the software industry has been a complex and controversial issue since the
76 Case 1.10 Gemstar-TV Guide International, Inc.
Collectibility is probable: The term “probable” in this context has the same meaning as in SFAS No.
5, Accounting for Contingencies. That pre-codification standard equates “probable” with “likely to
occur.”
In addition to these specific rules, the broad conceptual guidelines of accounting can be and
should be applied in determining when to record revenue for software sales or for the licensing of
2. If you study a sample of audit failures or breakdowns, I believe you will find that a fairly small
set of factors or circumstances are responsible for most deficient audits. The following list is not
intended to be comprehensive, but, nevertheless, I believe that these items are easily among the most
common antecedents to audit failures. [As a sidebar: students are better equipped to address this
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—A client that has engaged in a series of large and unusual transactions, particularly near the end of a
financial reporting period.
—Weak internal controls that can be easily overridden by client personnel.
audit failure or breakdown increases significantly. The final three items relate to auditors
themselves. Audit failures are much more likely when members of the audit engagement team lack a
proper degree of professional skepticism, competence (or adequate familiarity with the client’s
business and industry), or independence. When the two sets of “audit failure” factors intersect, then
the risk of a defective audit soars.
3. Statement of Financial Accounting Concepts No. 2 (pre-codification GAAP) defines materiality
as follows: “the magnitude of an omission or misstatement of accounting information that, in the
light of surrounding circumstances, makes it probable that the judgment of a reasonable person
relying on the information would have been changed or influenced by the omission or
misstatement.” The phrase “surrounding circumstances” ostensibly refers to key nonfinancial or
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analysis is that financial management and the auditor must consider both “quantitative” and
“qualitative” factors in assessing an item’s materiality.
Finally, SAS No. 107, Audit Risk and Materiality in Conducting an Audit” notes that “the
auditor’s consideration of materiality is a matter of professional judgment and is influenced by the
auditor’s perception of the needs of financial statement users.” In terms of specific factors to
particularly heavy emphasis on qualitative factors that may have been given short shrift by field
work auditors who for expediency and efficiency purposes placed a disproportionate emphasis on
quantitative materiality measures. (That is, field work auditors may be disinclined to take a “big
picture view” of the client’s financial data when they are focusing exclusively on inventory,
receivables, or some other financial statement line item that they have been assigned to audit.)
4. No doubt, Yuen’s point of view is one that is shared by many businesspeople and professionals.
An “anything goes if it is legal” mindset is certainly not consistent with the major ethical paradigms
of which I am aware. Consider placing this general issue in a context that your students should be
very familiar with. Are “earnings management” techniques or accounting gimmicks “ethical” as
long as they are not specifically prohibited by accounting standards. For example, is it ethical for
corporate management to defer year-end maintenance expenditures on production equipment so that
the company will reach its predetermined earnings goal?
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your students, ask them to identify a law that they consider to be unethical—instruct them to be
ready to defend that choice. Or, if you want, start with an example of your own drawn from the
accounting and financial reporting domain, namely, the Foreign Corrupt Practices Act of 1977. That
law specifically prohibits U.S. companies from paying bribes to officials of foreign governments to
establish business relationships. Although most U.S. citizens may believe that law enforces “right
conduct,” certainly a large number of businesspeople believe that it is unjust or unfair (unethical?) to