Help me come up with a discussion to respond back to this feedback below concerning revenue recognition about ths case attachedat the end of the feedback.
Site codification of what your references throughout thecase
Elaborate on the advertising services that the company provide andhow they cumulative revenue such as: ad view & number ofclicks
What factors contribute to miscalculation of revenuerecognition?
Elaborate on the Test of Control ex. Document, Review Procedure,& Separation of duties
Discuss Substantive Test give examples
Discuss Contract agreements
Social Konnections Inc. (SKI or the “Company”) 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 the Company went publicin 2010. SKI
currently has over 500 million active users who visit the site toconnect with others,
express themselves, and play games.
Last year, substantially all of SKI’s revenue came from advertiserswho market their
products and services to SKI’s active users through advertisementsplaced on the Web
site or its various mobile platforms. The Company’s remainingimmaterial revenue was
received from fees associated with the sale of virtual goods andservices by third-party
application developers using SKI’s various platforms.
In Q1 of the current fiscal year, SKI acquired CorporateCollaborations (CC), an entity
that manages private and public social media networks forcorporations. CC’s customers
are primarily national and global companies whose employees connectover its platform.
In addition to hosting private social media networks forcorporations, CC provides
services to develop the networks it manages. CC’s revenues areearned through the
performance of multiyear revenue contracts with its customers. Inthe current year, CC is
expected to produce approximately 20 percent of SKI’s consolidatedrevenue.
SKI’s investors are focused on the growth prospects of theCompany’s legacy open social
media platform operations and its new corporate revenue unit. TheCompany’s MD&A
disclosures include (1) various user and revenue metrics to helpfinancial statement users
assess its traditional operations and (2) backlog information tohelp users assess CC’s
operations.
Audit
Because of SKI’s continued growth, the audit committee hasrequested that the Company
choose a new audit firm with experience in auditing publictechnology companies. A new
firm was selected and has performed each of the interim reviews inthe current year.
Kristine Drew, a senior auditor, is the in-charge accountant on theSKI audit. In addition
to her supervisory and administrative responsibilities, Ms. Drew isresponsible for
auditing revenue. Ms. Drew has read the Company’s disclosedaccounting policies and is
interviewing the revenue controller, Bill Cook, and various salespersonnel to develop indepth
process flow documentation that will serve as the basis for theteam’s risk
assessment.
Advertising Revenue
SKI creates advertising space on its Web site and mobileapplications and sells the space
to advertisers either directly or through advertising agencies.According to Mr. Cook, the
amount an advertiser pays is dependent on the number of views thead receives or on the
Case 14-6c: Making Connections Page 2
Copyright 2013 Deloitte Development LLC
All Rights Reserved.
number of user clicks (depending on the type of advertisementdefined in the underlying
contract) 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
SKI’s advertising Web site at standard rates, with theadvertisements and terms input
directly into the Company’s ad delivery platform. However, mostadvertising revenue is
generated directly through the advertising sales team, which hasthe ability to help
advertisers develop more sophisticated advertising campaigns.Management has
established minimum pricing and volume thresholds for theseadvertisements; however,
the sales staff is given significant latitude in securing contractswith customers. Extra
commissions are paid to sales individuals who sign longer-termcontracts that meet
minimum revenue targets.
Once a contract is signed, the ad development department createsthe ad content and
obtains the customer’s approval. The approved ad and the contractare electronically sent
to the ad scheduling department, and the advertisement is uploadedinto the Company’s
ad delivery platform. The ad delivery platform is a robust systemand is designed to
capture all the nuances associated with the contract. For example,an advertiser may wish
to have its ads displayed only to users whose IP addresses are froma specific geographic
location, or the contract may be structured to provide theadvertiser with variable pricing
or incentives (such as a set of free advertisements) once a certainlevel has been paid for.
In summary, the delivery platform captures all the relevant pricinginformation associated
with the contract to allow for real-time revenue recognitionaccording to the terms of the
contract. After the contract is entered into the system, a summaryof the contract setup is
provided to the sales manager that worked with the customer. Thesales manager then
reviews the contract setup for accuracy.
The Company’s ad delivery platform automatically tracks theadvertising activity each
day and reports the activity to its customers, who are then billedweekly for the aggregate
ad activity.
Corporate Social Network Development and Hosting Revenue
As part of its new corporate services program from the acquisitionof CC, the Company
earns revenues by providing corporate social network developmentand hosting services.
For new customers, a contract will typically require an up-frontfee to SKI for the
development of the customer’s specific social media network; thecontract will also
include a separate multiyear hosting agreement. The customizedsocial media networks
only operate on the Company’s hosting platform, and customers donot have the option to
take possession of the software used to run the networks. Revenuesfor the up-front fee
associated with the development are recognized as the developmentis completed and the
system is available to the customer. Hosting revenues areautomatically recognized by the
system based on the invoicing cycle outlined within the customer’scontract. According
to Mr. Cook, this invoicing cycle is fairly uniform throughout thehosting period;
therefore, from a materiality perspective, the Company willdisclose that hosting fees are
recognized ratably throughout the hosting contract period.
Case 14-6c: Making Connections Page 3
Copyright 2013 Deloitte Development LLC
All Rights Reserved.
In Q4, during an interview with one of the new members of thecorporate sales team,
Ms. Drew was told that the corporate sales director had establisheda goal of increasing
the length of the average hosting contract. Before SKI acquired CC,most of the multiyear
hosting agreements were for three-year terms. In Q4, the corporatesales director
implemented a strategy shift that would increase the contractedhosting period to five
years. To accomplish this goal, the sales team was able to offerits customers three
months of free service, to be added at the end of any new five-yearagreement signed. In
addition, the sales director offered an additional commission forconverting existing
contracts to five-year agreements. To accelerate the implementationof this plan, the sales
commission is doubled if the contract modification occurs beforethe end of the fiscal
year.
Ms. Drew’s Concern
Ms. Drew is concerned about several things she has learnedregarding the appropriateness
of management’s revenue recognition policies.
