Ernst & Young will resign as the external auditor of E-commerce software provider Selectica Inc., according to a filing with the Securities and Exchange Commission. The San Jose-based company also identified material weaknesses in its internal controls in five accounting areas.

First, accounts receivable and services revenue incorrectly included a general reserve position in the allowance for doubtful accounts as of December 31, 2004, and incorrectly recorded a receivable as uncollectible as of March 31, 2005, for which payment was subsequently received after March 31 but prior to the completion of the quarterly close process.

Second, cash equivalents as well as short-term and long-term investments were not classified in the accordance with generally accepted accounting principles during the treasury process for Selectica’s India subsidiary.

Third, Selectica failed to reverse deferred revenue when all criteria for revenue recognition had occurred. The company also had insufficient controls for the identification of services to be provided to customers at no charge and recorded related revenue inappropriately.

Fourth, the company failed to record the expenses related to the benefits extended when employees were fired. The inadequate controls resulted in an adjustment as of March 31, 2005 to increase accrued payroll and related liabilities, and increase sales and marketing expense. Selectica also did not apply the appropriate accounting treatment for recording expenses related to the acceleration of stock options for a former executive. As a result, there was an adjustment as of March 31, 2005, to decrease additional paid in capital and sales and marketing expense.

Fifth, deficiencies in its financial statement close process included insufficient controls over the monitoring of the terms of employment agreements and bonus programs and determining the related appropriate accounting treatment. As a result, adjustments as of December 31, 2004, and March 31, 2005, decreased accrued payroll and related liabilities, and decreased general and administrative expense. The adjustments were recorded prior to the issuance of the respective financial statements, Selectica stated in the filing.

The company also cited insufficient controls over the monitoring of accrued liabilities recorded upon the sale of the company’s E-insurance business to Accenture in December 2003. The company said it had incorrectly not reversed the accrual when the related obligation expired on December 31, 2004. An adjustment as of that date to decrease accrued liabilities and decrease G&A expense was recorded prior to the issuance of the December 31, 2004, financial statements.

Selectica also noted in its filing that Ernst & Young’s reports on the company’s consolidated financial statements for the fiscal years ended March 31, 2004 and 2005 did not contain an adverse opinion or a disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. Selectica and its audit committee have initiated the process of selecting a new auditor to replace E&Y, the filing added.

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