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Question: After being in business for only two


After being in business for only two years, Your 1040 Return.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 OPERATIONS
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.
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. BecauseYour1040Return.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, Your 1040 Return. 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 refiling 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 atYour1040Return.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 ofYour1040Return.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 Gilbert – oversee the operations of the information technology platforms that host the tax preparation software andYour1040Return.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 individual’s usingYour1040Return.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 inYour1040Return.com’s financial statements.
[d] Indicate whatYour1040Return.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 toYour1040.com.
[g] Authoritative literature provides guidelines for proper revenue recognition policies for transactions such as those discussed in the case. AnalyzeYour1040Return.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 theYour1040Return. 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 affectYour1040Return.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 ofYour1040Return.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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