Your1040Return.

com
Evaluate eBusiness revenue recognition,
information privacy, and electronic evidence
issue
Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt

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Source: Auditing case, an interactive learning approach/ Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt
LEARNING OBJECTIVES

After completing and discussing this case you should be able to

[1] Identify business risks for Internet-only business models

[2] Recommend internal control improvements for an eBusiness-based company
[3] Understand selected eBusiness related revenue recognition issues
[4] Identify accounting issues that arise when Internet-only companies exchange banner ad services
[5] Recognize issues surrounding the privacy of customer information
[6] Describe audit implications when transaction evidence is solely electronic
[7] Recognize threats to eBusiness strategies, which rely solely on the delivery of services via the Internet

INTRODUCTION
After being in business for only two years, Your1040Return.com has quickly become a leading
provider of online income tax preparation and filing services for individual taxpayers. Steven Chicago
founded the company after a business idea came to him while shopping for individual tax preparation
software. As he stared at all the software packages on the shelves at a local computer supply store, the
following thought kept racing through his mind:

“With all of the tax law changes from year to year, why should I shell out $50 for a CD
that will be obsolete next year, not to mention the $20 I have to pay to file my taxes
electronically over the Internet? I’d rather pay a company a small membership fee to use
continually updated tax preparation software.”

Not long after his shopping experience, Chicago, an entrepreneur at heart, decided to create such a company.
Less than one year later, Your1040Return.com began operations in time for the next tax season.

OVERVIEW OF YOUR1040RETURN.COM OPERTIONS

Your1040Return.com is an entirely Internet-based tax preparation website for preparing and filing federal and state
individual income tax returns. Most of its revenues come from individuals seeking to avoid preparation of a paper-
based tax return and who are willing to “rent” access to a popular tax preparation software package through
Your1040Return.com. Other revenues come from individuals wanting to electronically file an already prepared paper-
based return.

For a minimal fee, Your1040Return.com provides an interface for individuals to electronically file their returns with
the appropriate federal and state regulatory bodies. Typical users come from middle class households wanting to
simplify yearly tax return preparation tasks. These users are generally searching for an accurate, easy, and economical
alternative to other professional tax services.

Individuals can access these services through Your1040Return.com’s website. To log on, customers must first register
for a user name and password. Once the customer indicates that he or she wants to register, the website asks the
customer to provide information including full name, mailing address, Social Security number, birth date, phone
number, email address, and a major credit card number. This registers the individual on Your1040Return.com’s
website and initiates the credit card approval process. Once the credit card number is validated, customers select from
one of three service packages: Silver, Gold, or Platinum.

The Silver package provides basic tax services, including electronic access to tax forms, schedules, and publications.
Customers can enter tax return information directly onto the forms and schedules, and Your1040Return.com will file
the completed materials electronically, eliminating the need for mailing paper copies to tax agencies. The Silver
package also provides a service that allows customers to apply electronically for a return extension. The Silver
package, however, does not give subscribers access to the tax preparation software package.

In addition to the benefits of the Silver package, the Gold package grants customers online access to a commercially
developed and continually maintained tax preparation software package. The package helps customers easily prepare
tax returns ranging from the simple 1040-EZ to a complex return, such as one filed by a self-employed businessperson
with nationwide real estate investments and actively traded securities. Both the Gold and the Silver packages provide
access to services for one tax season only.

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Source: Auditing case, an interactive learning approach/ Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt
Premium services are offered through the Platinum package, which allows customers to sign up for
Your1040Return.com membership ranging between two to five years. Through this multiple year package service,
customers receive year-round access to the tax preparation software provided to Gold customers, which allows them to
continually track changes to their tax basis in securities and periodically evaluate tax implications of possible
transactions. Furthermore, Platinum customers receive personalized attention and real-time tax support from qualified
income tax specialists, who work on a contract basis, via an online instant messenger program.

Your1040Return.com experiences high seasonal demand for its services from early February to the filing deadline of
April 15. Because Your1040Return.com allows customers to apply for filing extensions online, the company also
experiences strong demand for its services just before extension deadlines.

If the IRS finds a problem with a return submitted through the company’s Web service, Your1040Return.com does not
correct the problem, but informs the customer of the problem so that the individual can correct the error and refile the
return free of charge. The estimated frequency and cost of expected refilings are factored into the price of the service
packages.

Your1040Return.com does not handle tax refund or tax liability payments. If a customer is eligible for a refund, the
IRS remits the payment directly to the taxpayer. If a customer is required to pay income taxes, the IRS simply charges
the appropriate amount to the customer’s credit card number that is electronically submitted with the income tax return
or the customer can provide bank draft information to electronically transfer funds from the customer's bank account to
the IRS. Your1040Return.com assumes no liability for inappropriately filed returns or the tax positions of its
customers. All liability resides with the customer who prepared the return.

Your1040Return.com recognizes revenue differently for each product. The revenue for the first year of Platinum
service is recognized immediately after the customer selects this option. The company assumes customers will use the
package for an entire year without cancellation even though Your1040Return.com has a fairly simple cancellation
policy. All revenues from subsequent years of Platinum service are recognized in like manner. For the Gold package, a
portion of the revenue is recognized when the customer accesses the tax preparation software package via the Internet
for the first time. The company recognizes the remaining revenue when the customer submits the return to
the IRS. The company does not recognize revenue for the Silver package until the customer submits
a return to the IRS.

In addition to fees generated for its individual tax preparation services, Your1040Return.com engages in ad swapping
with a number of major Internet companies. For example, Amazon.com swapped a significant amount of advertising
with Your1040Return.com from January to April of this year. Amazon.com placed a banner ad on its website
reminding visitors to visit Your1040Return.com for all of their tax needs. In exchange for this ad,
Your1040Return.com placed a similar ad directing its visitors to shop online at Amazon.com.

SECURING CUSTOMER INFORMATION

Protecting unauthorized access to customer information is a high priority at Your1040Return.com. The
company houses its web server and microcomputers, which run critical applications, in a key-coded room
accessible only to the programmer and Chicago, the CEO. The web server is also protected by a proxy
server firewall to prevent outside hackers from attacking the database. In addition to these security measures,
all customers are required to create alphanumeric passwords that are at least six characters in length, to
prevent unauthorized access to customer accounts.

Your1040Return.com does not maintain a “bricks and mortar” storefront or interact face-to-face with
customers. The company engages in all transactions electronically and stores all purchase orders, sales
invoices, and advertising contracts in electronic form. The company backs up data daily, but the backup data
are not readily available at all times. After six months of soft storage on the company’s server network,
backup files are removed from the network to free up the limited storage capacity. The files are downloaded
to DVDs for storage and future retrieval. A significant upgrade of Your1040Return.com’s limited
information system is in the planning stages.

The company has hired several tax experts who monitor tax code changes and help ensure the underlying tax
preparation software is accurate. In addition, Your1040Return.com engages a national CPA firm to review
the accuracy of the tax preparation software. The company contracts with a software design firm that
develops the actual tax preparation online tools. Two of Chicago’s nephews – Nathan Randall and Matthew

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Source: Auditing case, an interactive learning approach/ Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt
Gilbert – oversee the operations of the information technology platforms that host the tax preparation
software and Your1040Return.com’s internal applications, including the company’s financial accounting
system software. Both of them have some prior experience in IT operations; however, each has less than 5
years of relevant work experience following their completion of undergraduate degrees in computer science.
Emily Parkin serves as the company’s CFO, responsible for Your1040Return.com’s accounting and
financial reporting activities. She joined Your1040Return.com after three years of audit experience with one
of the Big Four international accounting firms.

Given the growth in the number of individuals using Your1040Return.com’s services, several marketing
executives have recently begun to offer Chicago large sums of money to purchase Your1040Return.com’s
customer lists. Although Chicago has yet to formally draft an official privacy statement for his company, he
feels responsible for the privacy of his customers’ information and is unsure if he should sell the lists. The
cash offers have been tempting, however, given that the money would allow him to move ahead with
planned information system upgrades. In the meantime, Chicago arranged a line of credit with a local bank
to fund the upgrades. As part of that financing transaction, the bank has required an audit of
Your1040Return.com’s annual financial statements.

REQUIRED

[1] You are an audit senior with Gooch & Brown CPA, LLP, a local accounting firm specializing in audits
of information systems and financial statements. Your1040Return.com engaged your firm to perform its
financial statement audit. You have been asked by the partner to perform the following tasks:
[a] Why does Your1040.com need to have its financial statements audited? How might understanding
the reasons for the audit of the financial statements inform the auditor about potential audit risk?
[b] Describe to Steven Chicago why it is important for your firm to have an understanding of
Your1040Return.com’s business model.
[c] Identify Your1040Return.com’s major business risks and describe how those risks may increase the
likelihood of material misstatements in Your1040Return.com’s financial statements.
[d] Indicate what Your1040Return.com should do to improve its internal control.
[e] Explain what audit implications arise if you decide that the controls over electronic records at
Your1040Return.com are inadequate to ensure that records have not been altered.
[f] Steven Chicago has indicated that he is exploring upgrades to the company's IT systems. Your audit
partner would like you to explore whether cloud computing is an option that your firm might
recommend for consideration by Steven, Perform research to explain what cloud computing is and
why it might offer benefits to Your1040.com.
[g] Authoritative literature provides guidelines for proper revenue recognition policies for transactions
such as those discussed in the case. Analyze Your1040Return.com’s revenue recognition policies
for the three package services. Provide appropriate citations to authoritative literature.
[h] Explain how you can obtain evidence that ad swapping actually occurred between the
Your1040Return.com and Amazon.com. Describe accounting issues that arise when Internet-based
companies swap ad services and identify relevant authoritative literature.
[i] Address a memo to Steven Chicago detailing the appropriate contents for a customer privacy policy.
(You may want to visit other company websites, such as www.amazon.com, to see an example of a
privacy policy). Why is it important for Your1040Return.com to have an explicit privacy policy?
How might the lack of a policy affect Your1040Return.com’s financial statements in the future?

[2] Your1040Return.com’s main business strategy involves the delivery of services via the Internet. What
are some threats to the viability of Your1040Return.com’s business strategy?

[3] When customers register for the Platinum package, they have online access to tax professionals who are
paid on a contract basis. If you were in Steven Chicago’s shoes, how would you compensate those
professionals for their services? What controls could Your1040Return.com implement to ensure that the
company does not overpay for those professional services?

[4] Auditing standards provide guidance for auditors when evaluating electronic evidence. What are the
implications for an auditor when a client’s accounting system produces and stores transaction evidence
only electronically?

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Source: Auditing case, an interactive learning approach/ Mark S. Beasley · Frank A. Buckless · Steven M. Glover · Douglas F. Prawitt