ACCT8815 Hangu Chen, Jacob Lazar, Tanvir Rahman, Nick Takton, Yuxuan Zhao

[1] You are an audit senior with Gooch & Brown CPA, LLP, a local accounting firm
specializing in audits of information systems and financial statements.
Your1040Return.com engaged your firm to perform its financial statement audit.
You have been asked by the partner to perform the following tasks:

Jacob ​[a]​ Why does Your1040.com need to have its financial statements audited? How
might understanding the reasons for the audit of the financial statements inform the
auditor about potential audit risk?

The reason 1040Return.com wanted to do the audit was to be able to establish a line of
credit from the local bank in order to fund system upgrades. Therefore, as an auditor, you
want to look in the financial statements to see if management had any material
misstatements in order to make their company seem more stable than it is. They can do
this by overinflating their assets/lowering their liabilities and short term debt. We would
also look over the internal controls to make sure management cannot skew their
financials.

Jacob ​[b]​ Describe to Steven Chicago why it is important for your firm to have an
understanding of Your1040Return.com’s business model.

Understanding the client’s business model is essential for an audit as it helps the auditors
know how much audit evidence is needed for this audit. Without a good knowledge of the
business model, the auditor might fail to identify riskier accounts associated with the
business and therefore not get the appropriate amount of evidence. They are also more
likely to understand any incentives/pressures the employees face to reach certain
financial numbers.

Jacob ​[c]​ Identify Your1040Return.com’s major business risks and describe how those
risks may increase the likelihood of material misstatements in Your1040Return.com’s
financial statements.

The customer demand is seasonal in nature as most of their revenue comes during tax
season. Because their service is online too, this limits their customer base as fewer people
are willing to try the product. Another business risk is data privacy. As previously
mentioned, their tax services are offered online. This information is extremely private and
needs to be protected. If this information gets out, they could be liable for damages. They
could also have a problem with their tax software leading to many individual taxes being
wrong.
ACCT8815 Hangu Chen, Jacob Lazar, Tanvir Rahman, Nick Takton, Yuxuan Zhao

HC: ​[d]​ Indicate what Your1040Return.com should do to improve its internal control.

Your1040Return.com should develop a comprehensive internal control system and

consult with internal control experts. To be more specific, it should focus more on its data
privacy protection and revenue recognition principles. For data privacy,
Your1040Return.com should separate the duty of custody and the duty of operations
while keeping the data in the hand of experts hired externally. For revenue recognition
principles, Your1040Return.com should come up with a consistent rationale to address its
revenue recognition logic instead of arbitrarily recognizing revenue from different service
plans. Your1040Return.com should establish an accounting committee and hire more
experienced personnel as CFO.

HC: ​[e]​ Explain what audit implications arise if you decide that the controls over
electronic records at Your1040Return.com are inadequate to ensure that records have not
been altered.

Electronic records only impose great audit risks on Your1040Return.com engagement.

Auditors must conduct a closer inspection, do more substantive audit tests, and collect
more reliable evidence. At the same time, auditors need to assess the effectiveness of
internal control. If none of the above can give auditors a reasonable level of confidence,
auditors may choose to issue an adverse opinion or quite the engagement.

HC: ​[g]​ Authoritative literature provides guidelines for proper revenue recognition
policies for transactions such as those discussed in the case. Analyze
Your1040Return.com’s revenue recognition policies for the three package services.
Provide appropriate citations to authoritative literature.

According to the updated guidance in the Accounting Standards Codification Topic 606,
"Revenue from Contracts with Customers", the core principle for revenue recognition is
as follows:

"...the entity should recognize revenue to depict the transfer of promised goods or
services to customers in the amount that reflects the consideration to which the
entity expects to be entitled in exchange for those goods or services."

To achieve that core principle, ASC 606 notes that the entity should apply the following
steps:

Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

ACCT8815 Hangu Chen, Jacob Lazar, Tanvir Rahman, Nick Takton, Yuxuan Zhao

Step 4: Allocate the transaction price to the performance obligations in the

contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation.

Your1040Return.com uses different revenue recognition policies for three different

package services. For silver package customers, Your1040Return.com recognizes the
revenue when the silver package customers submit the tax return. For gold package
customers, Your1040Return.com recognizes a portion of the revenue when the customer
accesses the tax software package for the first time and recognizes the remaining portion
of the revenues when the customer submits the return. For platinum package customers,
Your1040Return.com recognizes revenues for each year immediately after the customer
selects the Platinum service.

Your1040Return.com should apply consistent revenue recognition principles to all three

kinds of services rendered. For example, Your1040Return.com can accrue the unearned
revenue first and recognize the realized revenue as it is earned. To be more specific,
Your1040Return.com can breakdown the service revenue and allocate it evenly across
the service period.

NT ​[h]​ Explain how you can obtain evidence that ad swapping actually occurred between
the Your1040Return.com and Amazon.com. Describe accounting issues that arise when
Internet-based companies swap ad services and identify relevant authoritative literature.

The auditor wants to get copies of the terms and arrangements that 1040return.com and
amazon.com have entered into. This would help to see if there are any problems
recognizing either revenues or expenses relating to ads. Although this is a non-monetary
transaction, there is still guidance as to the basis for valuation of ads, i.e. using fair
market value. So the auditor needs to learn the fair market value of revenues relating to
ads for both sites in addition to examining the contracts as to timing of ads so as to
evaluate the appropriateness of corresponding changes in accounts receivables and
payables as far as being reported in proper period.

NT ​[i]​ Address a memo to Steven Chicago detailing the appropriate contents for a
customer privacy policy. (You may want to visit other company websites, such as
www.amazon.com, to see an example of a privacy policy). Why is it important for
Your1040Return.com to have an explicit privacy policy? How might the lack of a policy
affect Your1040Return.com’s financial statements in the future?

This is important as far as protecting privacy of personal information the firm collects
from its customers because they should have confidence in the firm with which they
engage. The AICPA has particular guidance on this issue. Also, there are general
ACCT8815 Hangu Chen, Jacob Lazar, Tanvir Rahman, Nick Takton, Yuxuan Zhao

principles pertaining to privacy, including notifying customers about its policies before
personal information is collected. They could also make it a part of the process to require
consent and only the information needed and nothing beyond that need, as most
customers do not want to disclose such sensitive tax information. A lack of a policy
might cause a lower acquisition and/or retention rate of customers. Furthermore a lack of
policy may lead to misunderstandings as far as what the company uses the information
for and results in costly litigation.

TR ​[2] Your1040Return.com’s main business strategy involves the delivery of

services via the Internet. What are some threats to the viability of
Your1040Return.com’s business strategy?

There is a concern about customer demand because some people may hesitate to put out
tax related financial information over the internet, limiting the audience for this business.
This may result in pressure among managers to perform and result in inflated and
incorrect representation of the financial information.

There is another concern as to whether the software packages will properly understand
complex tax laws and keep them up to date. This could lead to litigation if done
improperly. Furthermore, any losses revenue, again, pressures management to perform
and make inflated and incorrect financial statement representations.

If the internet of a user fails, they might not be able to access this software and there
might not be a good enough offline backup for the customer to use, which might result in
revenue recognition issues. Likewise, having electronic only evidence means some data
may be lost, resulting in difficulty producing accurate financial statements.

The firm is small now and has a staff with limited experience, meaning that if the firm
grows, it may be more difficult to handle more business. In turn this might result in
misstatements due to errors in judgement.

Of course, as we stated, there is the concern of the privacy of customers, which might
result in litigation and require additional disclosures in the financial statements.

YZ ​[3] When customers register for the Platinum package, they have online access
to tax professionals who are paid on a contract basis. If you were in Steven
Chicago’s shoes, how would you compensate those professionals for their services?
What controls could Your1040Return.com implement to ensure that the company
does not overpay for those professional services?
ACCT8815 Hangu Chen, Jacob Lazar, Tanvir Rahman, Nick Takton, Yuxuan Zhao

I will also make them full-time employees so that the professionals may be contracted for
performing different services every month of the minimum number of hours on a regular
basis. Since these tax professionals would be very busy during the tax session, I would
compensate those professionals on an hourly basis so that professionals will get
compensation based on the number of extra hours they work on the tax return.

To ensure the company does not overpay, the professionals themselves are responsible to
submit a monthly list of the analyzed data, and we will have one manager to examine
every employee’s list and also compare with the relevant payrolls from other companies
to make our amount of salary fair. The website will allow the manager to check the tax
professionals’ status every time he/she wants so that the manager can use the database to
check whether the professionals submit the exact amount they work. The manager will
also make sure that tax professionals deliver appropriate tax services in exchange for
their salaries.

NT ​[4] Auditing standards provide guidance for auditors when evaluating electronic
evidence. What are the implications for an auditor when a client’s accounting
system produces and stores transaction evidence only electronically?

The important implication here is that the audit evidence’s sufficiency and relevance will
depend on the effectiveness of the firm’s internal controls. Furthermore, if controls are
not adequate, there might be increased chance that any errors are not detected.