Chapter 40 Auditing High Technology Companies.docx

Chapter 40 Auditing High Technology Companies.docx

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Chapter40AuditingHighTechnologyCompanies

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40

AuditingHighTechnologyCompanies

40.1OVERVIEWOFTHEINDUSTRY   

40.2RISKFACTORS,AUDITREACTION,ANDAUDITINGPROCEDURES   

（a）RevenueRecognition,   

（b）Field-ServiceOperations,   

（c）ComputerSoftwareSales,   

（d）BioscienceandTechnology,   

（e）ForeignOperations,   

（f）MaintenanceandServiceAgreements,   

（g）Inventory,   

（i）Obsolescence,   

（ii）Field-ServiceInventory,   

（iii）DirectMaterialsValuation,   

（iv）ConsignedInventory,   

（h）OverheadAccounting,   

（i）WarrantyAccruals,   

（j）ResearchandDevelopmentCosts,   

（i）SoftwareDevelopmentCosts,   

（ii）ContractedResearchandDevelopment,   

（iii）AcquiredTechnology,   

（k）IntercompanyTransactionsandTaxes,   

40.1OVERVIEWOFTHEINDUSTRY

Companiesthatincorporatenewtechnologiesintheirproductshaveexperiencedrapidgrowthandprovideddramaticnewproductofferingstotheworldmarkets.Additionally,theincreaseduseoftheInternetandintranetsforbothelectroniccommerceandinformation-sharingpurposeshashadasignificantimpactontheeconomy,asInternet-basedstart-upcompanieshaveproliferatedandtraditionaltechnologycompanieshaveallocatedsignificantresourcestoe-businessstrategies.Asaresult,hightechnologycompaniesarebecomingoneofthelargestindustriesintheU.S.andworldeconomies.Segmentsofthehightechnologyindustryincludecomputers,electronics,semiconductors,e-business,software,communications,instrumentation,robotics,biotechnology,medicaldevices,andotherappliedsciences.Thesebusinessesandtheproductstheyofferarediverse,buttheysharethefollowingcommoncharacteristicsthatresultintheirinclusioninthehightechnologycategory:

∙Intensiveresearchanddevelopment,whichgenerallycauseoperatinglossespriortoproductintroduction

∙Aneedtoidentifyfundingtosustainthecompanypriortoproductintroduction,andthereafterformarketingandsaleseffortsandworkingcapital

∙Productsthatderivevaluefromtechnologyasopposedtotheproductionprocess

∙Significantcompetitiveadvantageandrapidgrowthofcompaniesthatarefirstorsecondtomarket

∙Suddenemergenceofrapid-growthnichemarkets

∙Rapidgrowthintotalmarketandindividualcompanysize

∙Extensiveuseofresellersandthird-partychannelsasameansofincreasingdistributionvolumeandminimizingsellingandadministrativecosts

∙Rapidentryintointernationalmarkets

∙Highgrossmarginsthatshrinkrapidlyascompetingproductsareintroduced

∙Extensivewarrantyandcustomersupportcommitmentsthatresultinhighcustomerservicecosts

∙Rapidproductobsolescencecausedbytheintroductionofcompetingproductsutilizingmoreadvancedtechnologies

∙Frequentinstancesofproductsthatfailtomeetcustomerexpectationsorhaveshortlifecycles,resultinginrapiddownturnsforindividualcompaniesorentirenichemarkets

∙SignificantoperationsutilizingtheInternet/electroniccommercebusinessmodel

Inadditiontoprovidingthedefiningcharacteristicsofhightechnologycompanies,theseattributesareoftenthecauseofthemostsignificantauditissuesintheindustry.Suchissuesincludeprematurerevenuerecognition;impropercapitalizationofresearchanddevelopmentcosts;unexpectedinventorywrite-offs;andfailuretoappropriatelyaccountforsalesdiscounts,returnprovisions,andvendorcommitments.Furthermore,therapidgrowthexperiencedbymanyhightechnologycompaniesfrequentlyresultsincompaniesoutgrowingtheiraccountingsystemsandcontrols.

Thesefactorsandthefrequencyofbusinessfailuresinthehightechnologyindustrymakeitnecessaryfortheauditortoexerciseincreaseddiligenceinassessingrisk-includingtheriskthatthecompanywillbeunabletoobtainsufficientfundingtocontinueasagoingconcern-anddeterminingtheauditstrategyandinperformingsubstantivetests.Thischapterdiscussesuniqueaspectsofthehightechnologyenvironmentandtherelatedauditimplications.

40.2RISKFACTORS,AUDITREACTION,ANDAUDITINGPROCEDURES

Revenuerecognitionisakeyauditriskareainthehightechnologyindustry,largelybecauseoftheSecuritiesandExchangeCommission's（SEC）focusonit.Specifically,theSEChasrequestedthattheFinancialAccountingStandardsBoard（FASB）consideraddingseveral"Internet/dot-com"issuestotheagendaoftheEmergingIssuesTaskForce（EITF）.Inaddition,inDecember1999theSECstaffissuedStaffAccountingBulletin（SAB）No.101,RevenueRecognitioninFinancialStatements,whichinessenceextendedthefourcriteriaforrevenuerecognitionunderStatementofPosition（SOP）97-2,SoftwareRevenueRecognition（discussedinthemainvolume）,toallcompanies.TheSABcallsforstricterinterpretationsofcertaincharacteristicsofsalestransactions,suchasinstallation,customeracceptance,andupfrontfees,areasthathaveaparticularimpactonhightechnologycompanies.

Thecommoncharacteristicsofhightechnologycompaniescitedpreviouslycanincreasedramaticallytheinherentriskstowhichsuchcompaniesarevulnerable,aswellascontrolrisk.Auditareascommonlyaffectedbytheseincreasedrisksincluderevenuerecognition,inventory,field-serviceoperations,warrantyaccruals,andresearchanddevelopmentcosts.Theremainderofthischapterdiscusseshowtheauditorshouldidentifyandaddresssuchrisks.

（a）RevenueRecognition

Technologydevelopedbyavendoroftencanbeappliedtoalargenumberofdifferenttypesofproductatminimalincrementalcost.Therefore,itisnotuncommonforsalesandmanagementpersonneltostructurelargenumbersoftransactionssothateachisuniqueinsomemanner.Especiallyclosetotheendofanaccountingperiod,vendorscommonlyofferlargesalesdiscountsandotherconcessions,suchasproductwarranties,rightsofreturnorexchange,acceptanceclauses,orfreeservices.Theseuniquecontractualarrangementsmakethedeterminationofrevenuerecognitionmoredifficultthaninmanyotherindustries.

Severalhightechnologycompanieshaveexperiencedbusinessfailuresasaresultofinadequatecontrols,includingmonitoringcontrols.Insomeofthoseinstances,employeestookadvantageofthecompany'sineffectiveinternalcontroltorecordrevenuethatshouldhavebeendeferredaccordingtotheprovisionsoftherelatedsalescontracts.Suchprovisionsmaygrantrightsofreturn,exchange,oracceptance;extendedpaymentterms;andtherighttoreceiveadditionalproductsorservicesinthefuture;ormayspecifyothervendorobligations.Inassessingthecompany'sinternalcontrol,theauditorshoulddeterminethatmanagementhasestablishedandmaintainssufficientcontrolstoidentifyandproperlyaccountforsuchuniquesalesarrangements.Thiscommonlynecessitatesareviewofallmaterialnonstandardsalescontractsbyappropriatepersonnel.Controlsalsoareneededtoensurethataccountingpersonnelarenotifiedofcommitmentsmadebysalespersonnelthatarenotincludedinsalescontracts.

Theauditorshouldreadsignificantsalescontractsandexaminetherelevantfactsandcircumstancessurroundingindividualtransactionsinordertodeterminewhetherrevenuehasbeenrecognizedappropriately.Frequently,acompanywillnothavedetailedcustomerdocumentationsettingforththetermsofaparticularsale.Inthesecircumstances,theauditorshouldgiveseriousconsiderationtocontactingcustomersdirectlythroughdetailedconfirmationsthatincludethespecifictermsofsaleasrepresentedbythecompany.

Theauditorshouldnotconsiderrevenuerecognitioninisolationfromthecollectibilityoftherelatedaccountsreceivable.Inmanycases,theabilityofthevendortocollectreceivablesistheultimatedeterminantofwhenrevenueshouldberecognized.Significantreceivablebalancesthatremainuncollectedlongafterthebalancesheetdateordayssalesoutstandingthatareunusuallyhighmaycallintoquestiontheappropriatenessoftheentity'srevenuerecognitionpolicies.

（b）Field-ServiceOperations

Manyhightechnologymanufacturershavefield-serviceoperationsthatsupportequipmentthathasbeendeliveredandinstalled.Revenuesfromfield-serviceoperationsmaybebasedoncontractsorindividualservicecalls,dependingontheunderlyingserviceormaintenanceagreementwiththecustomer.Theauditorshouldbealerttoserviceandmaintenancecoststhatshouldnotbebilledtocustomersbecausethecustomerisentitledtotheservicesunderwarrantyagreements.

Field-serviceoperationstendtobegeographicallydispersedandcharacterizedbyalargevolumeoflow-dollar-valuetransactions.Thegeographicaldispersionoftenrequireslargeamountsoftestequipmentandpartsinventoryatmanylocations.Controllingtheseoperationsrequireseffectiveproceduresandmanagementsystems,whichmaynotbefullydeveloped.Internalauditparticipationinthisareaisoftencriticalinattainingadequateauditcoverage.

（c）ComputerSoftwareSales

AICPAStatementofPosition（SOP）97-2,SoftwareRevenueRecognition,addressessoftwarerevenuerecognitionprinciples.SOP97-2supersededSOP91-1,whichwasappliedbyanalogytorevenuerecognitionforhightechnologyproductsotherthansoftware.ItisexpectedthatSOP97-2alsowillbeappliedtononsoftwaresales.Ingeneral,SOP97-2requiresthatrevenuenotberecognizeduntiltheproductisdelivered;however,theSOPalsostatesthatrevenuemaynotberecognizedevenwhendeliveryhasoccurred,unlessallofthefollowingconditionshavebeenmet:

∙Evidenceofanagreementhasbeenobtained

∙Collectibilityoftherelatedreceivableisprobable

∙Thevendor