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Audit Case

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Accounting 440
Case 1

When auditors are determining when or how much revenue should be recognized, they call on a list of criteria in SABs 101 and 104 created by the SEC. The four main points that should be considered in making this decision are: 1. Persuasive evidence that an arrangement exists 2. Price must be fixed or determinable 3. Collectability must be reasonably assured 4. Delivery has occurred.
The first of this criterion is in place because the business must be able to show that a buyer has promised them revenue. The second means that the buyer and seller have agreed on the price. The third means that the seller can expect to get revenue. It is also important to know that unless a reasonable estimate of the amount of allowance for doubtful accounts can be made, revenue should not be recognized until it is possible to make an estimation or the entire payment has been received. And finally, ownership of the goods has transferred to the buyer and they have accepted them. These criteria are important in making sure that revenue is not recognized too early because financial statements need to be as accurate as possible. 1. AOL Software
The main issue to address for if AOL Software can recognize revenue is figuring out if AOL can use a 30%/70% split for recognizing revenue. Auditors should first find out why AOL decided to use the 30%/70% split. It should also be known if prices could be separated by software and Internet services, and what happens if customers go over 500 hours. From the information given, there is nothing that supports the 30%/70% revenue split. The delivery of the product and services is not a combined act because the service is provided for at least a year. Due to this, revenue should not be recognized immediately. Because the service portion happens monthly, AOL could recognize revenue at a monthly rate of $19.95. However, they should not be recognizing revenue by the 30%/70% method. 2. Modis Manufacturing
The important issue to address for Modis Manufacturing is the delivery of the goods. In addition to assessing the dispute over delivery, Auditors would want to gather information about when the payment is going to be received. They will also want to know when the building will be complete in order to know when delivery can occur.
From the information given, we can confirm that 2 out of the 4 conditions have been met. We know that the customer acknowledges that the agreement exists and has confirmed the amount. Although it does not state that collectability is assured, Modis met the contract date. In addition to that questionable condition, delivery has not occurred and there is no specific bill-and-hold agreement in the contract. Due to the fact that one condition is dicey and another has not been met, Modis Manufacturing should not recognize revenue.

3. Standish Stoneware
The key issue in determining whether revenue can be recognizes is the right of return. The information given states that Standish Stoneware grants its customers the right to a full refund or replacement within one year of purchase. In addition to this information, Auditors may want to find out return information from different companies with similar products. From this information they may be able to make reasonable estimates of the amount of returns. Since Standish Stoneware’s products are new and they do not have data on the history of returns, they cannot recognize revenue. The company should wait to record revenue until they can make a reasonable estimate for the amount of allowance for doubtful accounts, or when the return privilege has expired after a year. 4. Omer Technologies The most prevalent issue in this case is to see if the changes made to increase growth have affected any of the criteria for determining revenue recognition. From the information given, it sates that the only changes being made are a price break and an increased salesperson commission. In addition, it also states that product warranty and the right to return have not changed. The auditor should find out how much the price break is as well as how much more commission will be given. From the information given, it can be assumed that Omer Technologies has definitely met 3 of the 4 criteria for recognizing revenue. The only issue is finding out if the price is fixed or determinable. It should be assumed that when the salesperson makes an offer to a customer for the product, they would give them a set price that will be agreed upon for the product. Because of this, all 4 of the criteria have been met and revenue can be recognized. 5. Electric City The main issue in this scenario is the “pilot period” that Electric City offers. This pilot period allows customers to try the technology for six months before having to pay for it. Auditors should want to know the typical amount of returns for a similar product or even how the product does in Europe. In the information given, it does state that Electric City currently has a small provision made for potential returns but there is no rational for why they chose the amount that they did. Since payment is not reasonably assured when the “pilot period” starts, Electric City should not recognize revenue at this point in time. They should wait until they receive the money to recognize. 6. Jackson Products The important issue to look at is that they are not necessarily selling goods. They are selling two types of goods, old equipment and new equipment. In the information given it states that all of the sales were recorded as revenue. In regards to the new equipment, they could consider themselves a retail shop for the equipment and record those sales as revenue. However the old equipment should be considered a sale on a capital asset and the gain/loss on the equipment should be recorded. Because of this, auditors would want to know how much the old equipment was originally purchased for as well as any depreciation that was recorded on the equipment.

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