## Facts

- Star Technologies, Inc. (Star) manufactured high-speed computers.
- The Securities and Exchange Commission (SEC) instituted an administrative enforcement proceeding concerning Star’s fiscal year (FY) 1989 financial statements and related SEC filings.
- In 1989, Star entered an agreement with Glen Culler & Associates (GCA) under which Star advanced funds to GCA for research and development (R&D) of a new computer.
- GCA’s ability to repay the advances depended on the outcome of the R&D effort.
- In FY 1989, Star recorded the GCA payments as assets rather than recording them as R&D expense.
- The market for Star’s ST-100 computers had plummeted in the mid-1980s.
- Despite the market decline, Star projected it would sell 29 ST-100 computers in FY 1989, but sold only one refurbished ST-100 that year.
- Star nevertheless carried ST-100-related amounts at about $2 million on its books.
- As of FY 1989, Star reported accounts receivable totaling more than $6 million.
- Two receivables totaling more than $1 million had been outstanding for almost five years and had been referred to counsel for litigation.
- Star did not increase its reserve for bad debts to reflect the likely losses associated with those receivables.
- In 1987, Star obtained a loan that was scheduled to mature in 1990.
- In FY 1989, Star defaulted on the loan, giving the bank the right to call the loan immediately due.
- Star nonetheless classified the loan as long-term debt rather than as a current liability in its FY 1989 reporting.

## Issues

1. Whether Star’s FY 1989 SEC filings were materially misleading because the company’s accounting for contingent R&D advances, ST-100 valuation, allowance for doubtful accounts, and loan classification was inconsistent with generally accepted accounting principles (GAAP).
2. Whether recording contingent R&D advances as assets (instead of R&D expense) misstated Star’s assets and results of operations in FY 1989.
3. Whether maintaining about $2 million for ST-100-related amounts despite sharply reduced demand and minimal sales failed to reflect required write-downs under GAAP.
4. Whether failing to increase the bad-debt reserve for long-aged, litigated receivables overstated accounts receivable and net income in FY 1989.
5. Whether classifying a defaulted, callable loan as long-term debt (rather than a current liability) misstated Star’s liquidity and current obligations.

## Decision

- The SEC instituted an enforcement proceeding addressing Star’s FY 1989 financial reporting and disclosure.
- The SEC identified Star’s accounting treatments for (i) contingent R&D advances, (ii) ST-100 valuation, (iii) allowances for doubtful accounts, and (iv) classification of a defaulted loan as inconsistent with GAAP as reflected in Star’s SEC filings.
- The SEC’s release treated these reporting matters as significant to the accuracy of Star’s public financial statements and related disclosures in FY 1989.

## Legal Principles

- Public company financial statements filed with the SEC are expected to be prepared in conformity with GAAP; departures from GAAP can render filings misleading.
- Payments tied to R&D arrangements where repayment is contingent on project success generally raise recognition and classification concerns; treating such advances as assets can overstate assets and understate expenses.
- Inventory and product-related carrying amounts must reflect realizable value; where demand collapses or products become obsolete, GAAP may require write-downs to avoid overstating assets.
- When collection of receivables becomes doubtful—such as where amounts are long overdue and referred for litigation—GAAP requires recognition of expected credit losses through an appropriate allowance, rather than leaving receivables stated at amounts unlikely to be collected.
- A loan that becomes callable due to default generally affects current-versus-noncurrent classification; presenting callable debt as long-term can misstate current liabilities and liquidity measures.

## Conclusion

AAER No. 505 reflects the SEC’s administrative enforcement action focusing on whether Star’s FY 1989 SEC filings departed from GAAP by capitalizing contingent R&D advances, maintaining ST-100 amounts at levels not supported by market demand, failing to increase bad-debt reserves for aged litigated receivables, and classifying a defaulted callable loan as long-term debt, thereby calling into question the reliability of the company’s reported financial condition and results.


In re Star Technologies, Inc., Accounting & Auditing Enforcement Release No. 505 [1991-1995 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 73,964 (Nov. 15, 1993)