Based on the case below, answer the following questions:

1. Identify the potential revenue recognition issues related to each of the Company's

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

management's revenue recognition policies and determine whether those policies

are appropriately applied?

When working on this case:

- Identify the dilemma: explain the ethical support for alternative choices. Contrast reasons using prepositions:"Respect-for___," versus "Fairness- between_____&_____," versus "Consequences-of______" issues.

- Explain the Rights/Respect issues of who ought to have which rights based on promises, expectations, autonomy and dignity, not just laws. Use the phrase: "Respect for____" with our very limited sets of rights & duties: truth, promises, privacy, property, & health/body.

- Explain the Fairness/Justice issues in terms of treating equals the same and treating people with different of needs and earned differences, differently. Use the phrase: "Fair between ____&___."

- Explain the Benefits/Consequences in terms of who, when, size, and certainty of positive and negative consequences. Consider Long Run versus Short Run and use the phrase: "Consequences of______."

- Choose one position and explain WHY it is MORE ethical than the alternatives, refuting your support for the other positions. Where there is a dilemma, explain why ethical support for one choice is better than support for the other choices. Explain what about this case makes these ethical reasons more important.

Case 14-6

Making Connections

Social Konnections Inc. (SKI or the "Company") is a global Internet 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 public in 2010. SKI

currently has over 500 million active users who visit the site to connect with others,

express themselves, and play games.

Last year, substantially all of SKI's revenue came from advertisers who market their

products and services to SKI's active users through advertisements placed on the Web

site or its various mobile platforms. The Company's remaining immaterial revenue was

received from fees associated with the sale of virtual goods and services by third-party

application developers using SKI's various platforms.

In Q1 of the current fiscal year, SKI acquired Corporate Collaborations (CC), an entity

that manages private and public social media networks for corporations. CC's 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. CC's revenues are earned through the

performance of multiyear revenue contracts with its customers. In the current year, CC is

expected to produce approximately 20 percent of SKI's consolidated revenue.

SKI's investors are focused on the growth prospects of the Company's legacy open social

media platform operations and its new corporate revenue unit. The Company's 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 CC's

operations.

Audit

Because of SKI's continued growth, the audit committee has requested that the Company

choose a new audit firm with experience in auditing public technology companies. A newfirm

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 SKI audit. In addition

to her supervisory and administrative responsibilities, Ms. Drew is responsible for

auditing revenue. Ms. Drew has read the Company's disclosed accounting policies and is

interviewing the revenue controller, Bill Cook, and various sales personnel to develop in[1]depth process flow documentation that will serve as the basis for the team's risk

assessment.

Advertising Revenue

SKI 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 SKI through

SKI's advertising Web site at standard rates, with the advertisements and terms input

directly into the Company's 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 customer's approval. The approved ad and the contract are electronically sent

to the ad scheduling department, and the advertisement is uploaded into the Company's

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 Company's 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 SKI for the

development of the customer's specific social media network; the contract will also

include a separate multiyear hosting agreement. The customized social media networks

only operate on the Company's 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 customer's 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 SKI acquired CC, most of the multiyear

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 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. Drew's Concern

Ms. Drew is concerned about several things she has learned regarding the appropriateness

of management's revenue recognition policies.