SurfAnyTime
SurfAnyTime Inc. (SAT) is an Internet company that runs SurfAnyTime, a large social media
networking Web site. SAT has experienced steep growth since its launch in 2003, and the
Company went public in 2007. SAT currently has over 450 million active users who visit the site
to connect with others, express themselves, and play games.
Last year, substantially all of SATs revenue came from advertisers who market their products
and services to SATs active users through advertisements placed on the Web site or its various
mobile platforms. The Companys remaining immaterial revenue was received from fees
associated with the sale of virtual goods and services by third-party application developers using
SATs various platforms.
In Q1 of the current fiscal year, SAT acquired Corporate Collaborations (CC), an entity that
manages private and public social media networks for corporations. CCs customers are primarily
national and global companies whose employees connect over its platform. In addition to hosting
private social media networks for corporations, CC provides services to develop the networks it
manages. CCs revenues are earned through the performance of multi-year revenue contracts
with its customers. In the current year, CC is expected to produce approximately 20% of SATs
consolidated revenue in the current year.
SATs investors are focused on the growth prospects of the Companys legacy open social media
platform operations and its new corporate revenue unit. The Companys MD&A disclosures
include (1) various user and revenue metrics to help financial statement users assess its traditional
operations and (2) backlog information to help users assess CCs operations.
Audit
Because of SATs continued growth, the audit committee has requested that the Company choose
a new audit firm with experience in auditing public technology companies. A new firm was
selected and has performed each of the interim reviews in the current year.
Kristine Drew, a senior auditor, is the in-charge accountant on the SAT audit. In addition to her
supervisory and administrative responsibilities, Ms. Drew is responsible for auditing revenue.
Ms. Drew has read the Companys disclosed accounting policies and is interviewing the revenue
controller, Bill Cook, and various sales personnel to develop in- depth process flow
documentation that will serve as the basis for the teams risk assessment.
Advertising Revenue
SAT creates advertising space on its Web site and mobile applications 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 the ad receives or on the number of user
clicks (depending on the type of advertisement defined in the underlying contract) and the
revenue is recorded in the period in which the views or clicks are made.
Ms. Drew has learned that simple advertising can be purchased directly from SAT through SATs
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advertising website at standard rates, with the advertisements and terms input directly into the
Companys ad delivery platform. However, most advertising revenue is generated directly
through the advertising sales team, which has the ability to help advertisers develop more
sophisticated advertising campaigns. Management has established minimum pricing and volume
thresholds for these advertisements; however, the sales staff is given significant latitude in
securing contracts with customers. Extra commissions are paid to sales individuals who sign
longer-term contracts that meet minimum revenue targets.
Once a contract is signed, the ad development department creates the ad content and obtains the
customers approval. The approved ad and the contract are electronically sent to the ad
scheduling department, and the advertisement is uploaded into the Companys ad delivery
platform. The ad delivery platform is a robust system and 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 from a specific geographic location, or the contract may be
structured to provide the advertiser with variable pricing or incentives (such as a set of free
advertisements) once a certain level has been paid for.
In summary, the delivery platform captures all the relevant pricing information associated with
the contract to allow for real-time revenue recognition according to the terms of the contract.
After the contract is entered into the system, a summary of the contract setup is provided to the
sales manager that worked with the customer. The sales manager then reviews the contract setup
for accuracy.
The Companys ad delivery platform automatically tracks the advertising activity each day and
reports the activity to its customers, who are then billed weekly for the aggregate ad activity.
Corporate Social Network Development and Hosting Revenue
As part of its new corporate services program from the acquisition of CC, the Company earns
revenues by providing corporate social network development and hosting services. For new
customers, a contract will typically require an up-front fee to SAT for the development of the
customers specific social media network; the contract will also include a separate multi-year
hosting agreement. The customized social media networks only operate on the Companys
hosting platform, and customers do not have the option to take possession of the software used
to run the networks. Revenues for the up-front fee associated with the development are
recognized as the development is completed and the system is available to the customer. Hosting
revenues are automatically recognized by the system based on the invoicing cycle outlined within
the customers contract. According to Mr. Cook, this invoicing cycle is fairly uniform throughout
the hosting period; therefore, from a materiality perspective, the Company will disclose that
hosting fees are recognized ratably throughout the hosting contract period.
In Q4, during an interview with one of the new members of the corporate sales team, Ms. Drew
was told that the corporate sales director had established a goal of increasing the length of the
average hosting contract. Before SAT acquired CC, most of the multi-year hosting agreements
were for three-year terms. In Q4, the corporate sales director implemented a strategy shift that
would increase the contracted hosting period to five years. To accomplish this goal, the sales
team was able to offer its customers three months of free service, to be added at the end of any
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new five-year agreement signed. In addition, the sales director offered an additional commission
for converting existing contracts to five-year agreements. To accelerate the implementation of
this plan, the sales commission is doubled if the contract modification occurs before the end of
the fiscal year.
Ms. Drews Concern
Ms. Drew is concerned about several things she has learned regarding the appropriateness of
managements revenue recognition policies.
Required:
1. Identify the potential revenue recognition issues related to each of the Companys sources
of revenue.
2. On the basis of the information Ms. Drew has learned, what fraud risk factors should
she consider discussing with her team at the next fraud brainstorming meeting?
3. What potential audit procedures could the team consider to evaluate managements
revenue recognition policies and determine whether those policies are appropriately
applied?