CAN SOMEBODY HELP ME ON DELOITTE TRUE BLOOD CASE 14-6 "MAKINGCONCERN" ( details below )
Case 14-6 Making Connections
Social Konnections Inc. (SKI or the âCompanyâ) is a globalInternet company that
runs Social Konnections, a large social media networking Web site.SKI has experienced steep growth since its launch in 2005, and theCompany went public in 2010. SKI currently has over 500 millionactive users who visit the site to connect with others, expressthemselves, and play games.
Last year, substantially all of SKIâs revenue came fromadvertisers who market their products and services to SKIâs activeusers through advertisements placed on the Web site or its variousmobile platforms. The Companyâs remaining immaterial revenue wasreceived from fees associated with the sale of virtual goods andservices by third-party application developers using SKIâs variousplatforms.
In Q1 of the current fiscal year, SKI acquired CorporateCollaborations (CC), an entity that manages private and publicsocial media networks for corporations. CCâs customers areprimarily national and global companies whose employees connectover its platform. In addition to hosting private social medianetworks for corporations, CC provides services to develop thenetworks it manages. CCâs revenues are earned through theperformance of multiyear revenue contracts with its customers. Inthe current year, CC is expected to produce approximately 20percent of SKIâs consolidated revenue.
SKIâs investors are focused on the growth prospects of theCompanyâs legacy open social media platform operations and its newcorporate revenue unit. The Companyâs MD&A disclosures include(1) various user and revenue metrics to help financial statementusers assess its traditional operations and (2) backlog informationto help users assess CCâs operations.
Audit
Because of SKIâs continued growth, the audit committee hasrequested that the Company choose a new audit firm with experiencein auditing public technology companies. A new firm was selectedand has performed each of the interim reviews in the currentyear.
Kristine Drew, a senior auditor, is the in-charge accountant onthe SKI audit. In addition to her supervisory and administrativeresponsibilities, Ms. Drew is responsible for auditing revenue. Ms.Drew has read the Companyâs disclosed accounting policies and isinterviewing the revenue controller, Bill Cook, and various salespersonnel to develop in- depth process flow documentation that willserve as the basis for the teamâs risk assessment.
SKI creates advertising space on its Web site and mobileapplications and sells the space to advertisers either directly orthrough advertising agencies. According to Mr. Cook, the amount anadvertiser pays is dependent on the number of views the ad receivesor on the number of user clicks(depending on the type of advertisement defined in the underlyingcontract) and the revenue is recorded in the period in which theviews or clicks are made.
Ms. Drew has learned that simple advertising can be purchaseddirectly from SKI through SKIâs advertising Web site at standardrates, with the advertisements and terms input directly into theCompanyâs ad delivery platform. However, most advertising revenueis generated directly through the advertising sales team, which hasthe ability to help advertisers develop more sophisticatedadvertising campaigns. Management has established minimum pricingand volume thresholds for these advertisements; however, the salesstaff is given significant latitude in securing contracts withcustomers. Extra commissions are paid to sales individuals who signlonger-term contracts that meet minimum revenue targets.
Once a contract is signed, the ad development department createsthe ad content and obtains the customerâs approval. The approved adand the contract are electronically sent to the ad schedulingdepartment, and the advertisement is uploaded into the Companyâs addelivery platform. The ad delivery platform is a robust system andis designed to capture all the nuances associated with thecontract. For example, an advertiser may wish to have its adsdisplayed only to users whose IP addresses are from a specificgeographic location, or the contract may be structured to providethe advertiser with variable pricing or incentives (such as a setof free advertisements) once a certain level has been paid for. Insummary, the delivery platform captures all the relevant pricinginformation associated with the contract to allow for real-timerevenue recognition according to the terms of the contract. Afterthe contract is entered into the system, a summary of the contractsetup is provided to the sales manager that worked with thecustomer. The sales manager then reviews the contract setup foraccuracy.
The Companyâs ad delivery platform automatically tracks theadvertising activity each day and reports the activity to itscustomers, who are then billed weekly for the aggregate adactivity.
As part of its new corporate services program from theacquisition of CC, the Company earns revenues by providingcorporate social network development and hosting services. For newcustomers, a contract will typically require an up-front fee to SKIfor the development of the customerâs specific social medianetwork; the contract will also include a separate multiyearhosting agreement. The customized social media networks onlyoperate on the Companyâs hosting platform, and customers do nothave the option to take possession of the software used to run thenetworks. Revenues for the up-front fee associated with thedevelopment are recognized as the development is completed and thesystem is available to the customer. Hosting revenues areautomatically recognized by the system based on the invoicing cycleoutlined within the customerâs contract. According to Mr. Cook,this invoicing cycle is fairly uniform throughout the hostingperiod; therefore, from a materiality perspective, the Company willdisclose that hosting fees are recognized ratably throughout thehosting contract period.
,
Ms. Drew was told that the corporate sales director hadestablished a goal of increasing the length of the average hostingcontract. Before SKI acquired CC, most of the multiyear hostingagreements were for three-year terms. In Q4, the corporate salesdirector implemented a strategy shift that would increase thecontracted hosting period to five years. To accomplish this goal,the sales team was able to offer its customers three months of freeservice, to be added at the end of any new five-year agreementsigned. In addition, the sales director offered an additionalcommission for converting existing contracts to five-yearagreements. To accelerate the implementation of this plan, thesales commission is doubled if the contract modification occursbefore the end of the fiscal year.
Ms. Drewâs Concern
Ms. Drew is concerned about several things she has learnedregarding the appropriateness of managementâs revenue recognitionpolicies.
Required:
Identify the potential revenue recognition issues related toeach of the Companyâs sources of revenue.
On the basis of the information Ms. Drew has learned, what fraudrisk factors should she consider discussing with her team at thenext fraud brainstorming meeting?
What potential audit procedures could the team consider toevaluate managementâs revenue recognition policies and determinewhether those policies are appropriately applied?
