Problem $2.$

Ulta is a specialty beauty retailer. It has physical stores, makes digital sales, and a loyalty program. The auditing firm, Ernst and Young, singled out the loyalty program as a critical matter in the course of the audit. This does not means they found anything wrong. It only means that the financial statements are sensitive to the method of accounting. In this case, the financial statements are sensitive to the estimates.

The auditing firm states this:

Loyalty Program

dscription of the The Company maintains a loyalty program, Ultamate Rewards, which offers members the ability to earn matter and redeem points on purchases of products and services. $[...]$

Auditing the Company's estimate of loyalty deferred revenue was complex as the calculation involved management's assumptions, such as the standalone selling price and expected redemption rate, which drive the revenue deferral. In particular, the estimate is sensitive to these significant assumptions, which are affected by expestations about future customer behavior.

How we addressed the matter in our audit

We obtained an understanding, evaluated the design, and tested the operating effectiveness of the Company's estimation process and controls supporting the measurement and recognition of the amount of loyalty revenue deferred. This included testing controls over management's review of the assumptions and other inputs used in the estimation, the completeness and accuracy of issuance and redemption data used in the calculation, and controls over the assignment of membership levels based on customer spending patterns.

Our audit procedures included, among others, evaluating the methodology used, analyzing the significant assumptions discussed above, and testing the accuracy and completeness of the underlying data used in management's calculation. To test the standalone selling price per point, we validated that the price per point for each membership level was appropriate based on products or services purchased by loyalty members. To audit the redemption rate, we tested redemption activity and compared the results of that testing to the redemption rate used by management in its estimate. In addition, we tested the value of points redeemed was complete and accurate. We also considered recent trends in redemption activity and the impact on the redemption rate. In addition, we performed sensitivity analyses of significant assumptions to evaluate the change in the deferral amounts.

Ulta has this to say about the loyalty program:

Loyalty program

The Company maintains a loyalty program, Ultamate Rewards, which allows members to earn points based on purchases of merchandise or services. Points earned are valid for at least one year. The loyalty program represents a material right to the customer and points may be redeemed on future products and services. Revenue from the loyalty