Logenta 9.3

Auditing Cases: An Interactive Learning Approach (4th Edition)

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9.3 Case Instructional Notes Longeta Corporation: Facts The student completing the case is assuming the role of a hypothetical new staff auditor on the Longeta Corporation financial statement audit. T The staff auditor is responsible for auditing revenues at Longeta. Longeta Corporation is a California-based developer and marketer of software used to manage data storage functions for complex computer networks. Longeta sells products to intermediaries who in turn sell the products to government purchasers and other organizations. The audit relates to Longeta s fiscal year ended September 30, 2006. Most of the audit work related to revenue accounting is complete. There is one particular transaction that the staff auditor is evaluating. It relates to a proposed transaction with a third-party intermediary. The third-party intermediary involved in this transaction is Magicon, who will resell the software to the U.S. Air Force. The size of the transaction is $7 million, which is material to Longeta. The transaction relates to the sale of both software and related support services. Magicon placed an order letter just before September 30, 2006. In negotiating the order letter, Magicon requested the right to cancel its obligation to pay Longeta if final terms could not be arranged. Longeta s Vice President of Sales issued a separate letter to Magicon noting that the terms and conditions of the transaction have not been finalized. In fact, the letter acknowledges that the terms and conditions must be mutually agreed upon within 30 days (which is after the fiscal year end). The letter also gives Magicon full rights to return with no commitment to pay in the event the terms and conditions cannot be satisfactorily determined. Based on the order letter and separate side letter from the Vice President of Sales, Longeta recorded the $7 million transaction for the year ended September 30, 2006, with $5.8 million treated as revenue and the remaining $1.2 million treated as deferred revenue. 1. Research required accounting treatment criteria related to revenue recognition to make sure you have a clear understanding of the explicit criteria that must be satisfied before revenue can be recognized. The Securities and Exchange Commission s (SEC) Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, provides a good summary of the key required elements. Read the SEC s guidance and document the four criteria the SEC believes must be satisfied for revenue recognition. The determination of whether a company is reporting transactions within the confines of GAAP (aggressively reporting versus fraudulently reporting) requires professional judgment. In order to record revenue transactions, the SEC s SAB No. 101 notes that GAAP requires the following conditions to be
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satisfied: 1. Evidence of an arrangement exists. 2. The earnings process is complete or nearly complete. Thus, the company has performed the service or provided the product and an exchange has taken place. In
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Logenta 9.3 - 9.3 Case Instructional Notes Longeta...

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