Starcom travails highlight accounting problems for small-caps

If Q and James Bond quit Her Majesty's secret service to sell Q's bugs and other gadgets to the private sector, they might struggle in much the same way as Starcom, Israeli maker of devices that track people, pets and freight.

Last week the company - whose founders include telecoms entrepreneur Avi Hartmann; his son Uri, a former Israeli military intelligence officer, and Doron Kedem, who formerly worked with Israeli police tracking stolen cars - announced not only would it miss this year's forecasts by a country mile but it would also have to restate last year's profits.

It turns out that the company, which joined the Alternative Investment Market in early 2012, has been logging sales of its smart locks and tracers without the goods ever leaving its warehouse. Under a "bill and hold" accounting policy, used by companies the world over, it has been booking income when distributors put in orders, not when they pay.

Starcom chairman Michael Rosenberg, a serial Aim director, former chairman of Numis Securities and author of children's books, says he has a hearty dislike for "recognising revenues until [the goods] have been delivered and paid for." But until last year Starcom's revenues booked under this system were negligible. 

Alarm bells began to ring for Mr Rosenberg a few months ago when "book and hold" orders rose but more distributors failed to draw down as promised and pay for stock allocated to them. Moreover, many Starcom customers are in distant markets, says Mr Rosenberg. And while multinationals and James Bond can jet set between continents to verify orders, Starcom found it difficult to "test the financial risk".

He was right to worry. Revenue recognition is at the heart of many an accounting to-do. Last week, Blur, the online services exchange, again stumbled over the way it accounts for sales. So too have Quindell, the software-insurance business, Tesco and IBM, the computer giant.

It is particularly tough for small companies to judge when to report revenues on long-run projects where cash comes in later. The temptation is to book costs slowly and income fast to lift profits, even if temporarily. Beancounting watchdogs, fretful that over-optimistic bosses may be encouraged to ignore the risks and run out of cash, toughened their rules last year. Nonetheless, accounting treatments such as "bill and hold" shows that revenue recognition is still an art rather than a science.

For Starcom shareholders, restating numbers bears a heavy cost. The shares are trading at 7.25p against a float price of 20p. The group's restated revenues for 2013 will fall from $9m to $6.2m. And revenues are expected to be $5.3m for 2014. Pre-tax profits of $0.79m have been restated as a $0.9m loss. Working capital requirements have increased, too, although the board says it is "confident" it can manage its funding requirements and most of the lost revenues will be recouped in 2015.

And while Starcom's board should be lauded for recognising the error of its accounting ways, it can ill-afford to err again. James Bond may have been given multiple face lifts and allowed to fight another day. Boards that persistently disappoint investors are rarely given such leeway.

So Rangers International Football Club has been relegated from Aim after just two years as a public company. Few emerge glorious from this episode of junior market history. The best that can be said is that Rangers has exposed the gaps in regulation of Aim that rulemakers should now look to plug.

Last week, another hole emerged. Accountants Deloitte, having previously indicated its concerns about Rangers as a going concern, told the board in November that it was quitting as auditor. That might have alerted shareholders to the company's predicament, but they weren't informed.

The Financial Conduct Authority says fully listed public companies must disclose material issues, which might include the resignation of the auditor, but Aim falls outside its ambit. The Financial Reporting Council, guardian of the corporate governance code, asks for reports on audit effectiveness and tenure but that's as far as it goes. And again the obligations on Aim companies are looser.

Regulators could do a lot to improve investor protection by insisting that companies inform shareholders if their auditors hand in their notice.

[email protected]

© The Financial Times Limited 2015. All rights reserved.
FT and Financial Times are trademarks of the Financial Times Ltd.
Not to be redistributed, copied or modified in any way.
Euro2day.gr is solely responsible for providing this translation and the Financial Times Limited does not accept any liability for the accuracy or quality of the translation