Gemstar Case Questions 2023.11.10

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Feb 20, 2024

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Gemstar-TV Guide International In class, we will debate the wisdom of the actions taken by Gemstar’s Audit Committee. Each team will nominate Board of Directors Members to act as your representatives during the class discussion. Required: To be completed in teams. a. Prepare brief written responses to the two questions below. Responses should be thoughtful but concise. Submit one copy of your responses per team on Canvas. b. Elect one team member to be your Board of Directors representative during class discussion. Your representative will defend your team’s responses to the questions below. Two notes: (i) The team representative should be prepared to defend the team’s responses without assistance from other team members . (ii) Practitioners, regulators, and researchers are all examining the potential benefits of diversity on boards, where diversity can arise through differences in education, work experience, life experience, background, nationality, race, religion, gender, and other factors. If you are one of the later groups to pick a Board member, you can review the other Board members’ bios (accessed via the Google Doc link on Canvas) to get a sense of the other members’ backgrounds and skills. Pick a Board member who will complement the existing members. c. Board representative only (only one person per team): i) Put your name and bio in the Google Document for selected Board Members. Questions: Assume you are a member of Gemstar’s Audit Committee in answering the following questions. Although GAAP have changed since this case took place, you should base your responses on the accounting rules that were in place in 2001 (as described in the case). 1) The Audit Committee’s review of the 2001 Financial Statements audit. In early 2002, the Audit Committee met to review the results of the 2001 audit. One issue of concern was Gemstar’s continued recognition of revenues on expired StarSight patent contracts with Scientific-Atlanta. KPMG had approved Gemstar’s recognition of revenues on the StarSight patents, but did require Gemstar to disclose certain information about the revenues and concentration of accounts receivables (see page 8 and Exhibit 4 in the Case). The Audit Committee considered the issue in detail but ultimately “did not seek to change management and the auditor’s conclusion” (page 8). 1

Assume you are an Audit Committee member sitting in the aforementioned meeting. Like the original Audit Committee members, you do not have access to any information revealed by the subsequent investigations discussed in the case. You may ask whatever questions you want of Gemstar’s management or KPMG. Do you agree with the Scientific-Atlanta accounting treatment and allow the financial statements to be reported? Explain why or why not. What are the potential implications of your decision? 2) The Audit Committee’s review of the Valukas investigation. In June 2002, the Audit Committee had to decide how to respond to the results of the investigation performed by Tony Valukas. The major point of contention was the accounting treatment of the Fantasy Sports transaction. At the time, the accounting rule relating to non-monetary transactions (also known as barter transactions) was to record the transaction at the more readily determinable of the value of the consideration given or the value of what is received. Gemstar determined the value of the advertising given “based on cash transactions for similar advertising sold to other parties” (page 6). Gemstar recorded the Fantasy Sports transaction as follows: Cash Intangible Assets = Advertising Owed Retained Earnings Revenue - Exp. = Net Income Buy IP & Option -750 +20,750 = +20,000 - = Once Advertising was delivered -20,000 +20,000 +20,000 +20,000 Valukas’s investigation uncovered the emailed discussed on pages 11 and 12 of the case. The Audit Committee determined that the $20 million of revenues should be reversed, which would require a restatement of the 2001 Financial Statements. Gemstar’s management and KPMG disagreed with the Audit Committee. The SEC and Nasdaq were demanding that Gemstar file its financial statements or face significant consequences. The case notes that “the Committee was left with two choices: agree with KPMG or fire them” (page 13). As a member of the Audit Committee, what do you do at this point? Do you go along with KPMG, fire them, or are there other solutions you may pursue? What are the potential implications of your decision for the firm, its shareholders, and yourself? Again, you may only consider information available to the original Audit Committee members (i.e., all information provided in the Case is fine, but do not search for additional information released afterward). 2

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