Summary

Soon after completing his college degree Nick was hired in the accounting department as a junior auditor for his aunt’s software company, O’Brian Software. His aunt Amelia holds the CEO position but does not have enough accounting knowledge of the company. The started as a small family firm and then went public.

Going over financial statements and reviewing the company’s software revenue data, Nick noticed that revenue estimates were too conservative compare to the actual company revenues. He considered a possible case of reserves to inflate earnings in slow earning periods. This could mislead investors and create a negative financial reputation situation that would not benefit the company’s newest software launch “BrainWave”.

Nick discuss what he believes are revenue recognition issues with Marchetti, the company’s CFO in control of all the financial activity of the company. Marchetti explains to Nick that O'Brien Software's "deferrals and estimates are well documented and in accordance with the Securities and Exchange Commission rules. After speaking with Marchetti, Nick spoke with his aunt Amelia about his concerns. Aunt Amelia not knowing enough about the financial situation or accounting in general, asked Nick if she should mention the issue to the audit committee. Aunt Amelia now needs to make the decision to whether or not report the revenue recognition concerns the audit committee.

Issues

One of the issues is the concern if the company is using aggressive conservative revenue recognition to build reserves to use in future periods when earnings will decrease. This method is illegal because it would not provide a realistic financial statement to investors.

One other issue is the company CEO lack of accounting knowledge. This is a very important issues because if Aunt Amelia would understand if revenue were being smoothed or not she would be able to prevent the problem. Aunt Amelia can be held reliable of any company financial statement distortion, and simply using the excuse of not having the accounting knowledge won’t not free her of the responsibility of keeping the reports in compliance.

The final question is if Aunt Amelia should report the presumed revenue recognition issues to the audit committee or not.

Standards and practices

Before moving forward Nick should research and review the software revenue recognition standards. As stated by Statement of Position 97-2 Software Revenue Recognition, revenue is realized and earned when all of the following criteria are met: Persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the vendor’s fee is fixed or determinable, and collectability is probable (FASB, 2013).

Audit committees are part of the company board of directors. They must be composed of independent directors with no personal, financial, or family ties to management. They act to protect investor interests overseeing, financial reporting, audit activities, and compliance with applicable laws, regulations, and the company ethical standards, assuring integrity of financial reports. The board is ultimately accountable to investors for the company’s performance, affairs, and business. The audit committees are responsible to hire expertise in the areas of financial reporting, internal controls, risk management, and audit activities. Management is responsible to communicate with the audit committee about the areas that may cause any financial risk to prevent or detect any financial misstatement (Rezaee, 2009) .

Nick will need to interpret revenue recognition for a software company because quite few factors need to be analyzed. Revenue can be accounted on signed contract. If the vendor operates without relying on a signed contracts to document the revenues and liabilities they should provide other forms of evidence to document the transaction. For revenue recognition base on
Delivery, it can be applies when the customer takes possession of the software or download the electronic copy.

Referring to aunt Amelia lack of accounting knowledge we can discuss The Sarbanes-Oxley Act of 2002 (SOX), legislation that was created after big accounting scandals to improve company financial clarity. Section 302 of The Sarbanes-Oxley Act states that each periodic report containing financial statements filed by the company with the Securities Exchange Commission must be accompanied by a written statement by the CEO and CFO, that certifies that the financial reports are in compliance with SEC requirements. Alterations of financial statements can be fined and may result in 20 years imprisonment.

Opinion.

In my opinion conservative accounting should not be allowed and none of the revenues should be estimate. Revenue should only be recognize when the transactions are completed and reported exactly as stated on invoices and other documentation. Investors need to receive a realistic picture of the firm financial situation and smoothing revenues is an intended action to distort statements and mislead investors.

Nick will need to analyze in detail the company revenue recognition provenience before moving forward to report to the committee. Generally audit committee provide three reports. First is the regular report of the meetings to the company’s board of directors describing the committee’s agenda, activities, deliberations, and recommendations. Second is the formal annual report to the board of directors, summarizing its authorities, duties, oversight responsibilities, resources, funding, performance, recommendations, and deliberations for the past year and its agenda for the coming year. Third, the audit committee should prepare and submit a formal annual report to the shareholders stating the financial standards prepared in accordance with GAAP are included in the annual report on Form 10-K and the audited financial statements with management. Once the audit committee will report findings unreported financial reserve the company will risk to lose the investors trust and the continuity of the company.

It’s very important for Nick to inform and discuss the requirements of SOX section 302 with Aunt Amelia. CEO should be aware of the financial situation of the company.