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Contributed 1/12/00 by Keith Brazile <keith.brazile@eds.

com> Revenue Recognition Audit Guide Audit Objectives: * To ensure that the accounting methods used for revenue recognition are appropriate. * To ensure that the accounting methods are properly applied and the recorded balances of contract revenue, cost of revenue, unbilled receivables, accrued receivables, deferred revenue and contract concessions are accurately stated. * To ensure that contracts in a "high-risk" development phase are accounted for at an assumed zero profit (i.e. revenue recognized equals cost expensed). * To ensure that assets associated with the contract (unbilled receivables, fixed assets, etc...) are recoverable through the operation of the contract. * To ensure that liabilities incurred by the contract have been properly recorded in the appropriate periods. * To ensure losses on loss contracts are provided for when they become apparent. Audit Procedures: 1. Obtain and read the Contract and any other contract related documents (i.e. Letter of Intent, Memo of Understanding, etc.). 2. Send the appropriate contract questionnaire (POC or As Billed) to the account. Send as early as possible so the account has plenty of time to adequately complete the questionnaire. 3. Review the contract questionnaire and contract summaries prepared by the account team to be sure that the following are specifically addressed: a. Total Contract Value and length of term. b. Type of Contract (e.g. fixed price, cost plus, time and material, unit price). c. The method of billing the customer (fixed fee, man-hours, etc...). d. Unique contract clauses. e. Significant accounting areas and audit issues. f. Summary analysis of the POC model including the revenue recognition methodology 4. Obtain, from account management, a list of known contract issues and any items still pending negotiation. These can be issues related to the customer, the contract, Our performance under the contract, deliverables, etc. Review these issues with management to determine if any of the issues are significant enough to classify the contract as a high-risk contract or have an impact on the collectability of any unbilled revenue. 5. Obtain the most recent unbilled approval package or other available documentation that was used to evaluate the opportunity to enter into the contract. Review the documents for an analysis of business risks and specifically, high-risk elements that would impact management's ability to estimate total contract revenue or cost. Contact External Reporting to obtain their knowledge regarding the contract and revenue recognition issues. The Unbilled Approval Package for long term contracts should include at a minimum: a. Memorandum of explanation b. Schedule of financial assessment c. New Business Risk Assessment Module and Approval Control Sheet d. Point of Sale New Business Analysis model, including detail of assumptions supporting the model e. Percentage-of-completion model, including quarterly results over the term of the contract f. Schedule of termination charges versus unbilled balances 6. Compare the most current POC model to the most recent Unbilled Package to determine that the any approved unbilled timetables are being adhered to (i.e. all unbilled has to be recognized by a certain date, or any limitations on the amount of revenue to recognized is adhered to). The recovery period of the unbilled revenue is limited to 70 percent of the original term of the contract for all contracts greater than two years in duration, provided the recovery period cannot be less than two years (to the nearest quarter). This standard recognizes that most long-term contracts are renegotiated or renewed prior to the end of the original contract. Unbilled receivables are subject to re-approval if: a. Estimates exceed 110 percent of original maximum approved limit. b. The actual unbilled balances exceed quarterly estimates (per approved model) by the lesser of 25 percent or US$1 million. c. A substantial change to the contract (extension, renewal, material re-pricing) occurs. d. Contracts that have completed a "high-risk" phase require re-approval before any profit recognition adjustment on services performed to date can be made. 7. Obtain the most current detailed cost model or updated point of sale model along with documentation supporting the assumptions used in the preparation of the model. The model should be in the form of an income statement with actual results for past periods and estimated results for future periods. It should be detailed in nature, including separate revenue line items for each service element and separate cost line items for each type of cost (labor costs, communication charges, etc...). a. If the contract is large and has a very complex cost model, it may be appropriate to select a few segments of the model to review rather than reviewing 100% of the model. If this approach is taken be sure to look at the most significant segments in terms of risk and complexity. b. Perform an analytical review of the updated cost model. Determine whether current year actual billings and direct expenses are in line with projections per the model.

c. Have the account perform a trend analysis of the changes in revenue and expense components, using the last 4 quarters of actual data. Document causes of trends, expectations regarding the current year amounts, and the reasonableness of current year balances in light of these items. Investigate unusual items. d. Obtain documentation of the assumptions underlying management's estimates of future billings, significant costs, costs that are forecast to improve and other significant/unusual changes in the model. Review the assumptions to enable an evaluation of the reasonableness of management's estimates and the assumptions used. Compare future revenue streams to items identified in the contract to determine if future revenue forecasts include any unsold new business. Unsold new business is revenue that is not specifically provided for in the contract. It may be referred to as "probable" or some other description that indicates that it is only a possible revenue source as opposed to a contractually certain revenue source. This revenue cannot be considered in the calculation of revenue to recognized. e. Review the consistency of the gross margin through the life of the contract. Compare the actual current year gross margin to the margin realized in prior years and the overall projected life of the contract. Determine the cause of fluctuations and whether the fluctuations are indicative of using an inappropriate revenue recognition method. f. If the updated model indicates a loss on the contract as a whole, the entire loss must be recognized immediately. The remainder of the contract should be set to a zero profit recognition basis. g. For contracts with high unbilled and/or high-risk elements, discuss the contract with account management in order to clearly understand the contract deliverables. If the success of the contract is contingent upon a higher risk element (development of software, implementation in a complex environment, complex consolidation or migration of facilities from a customer) then management's ability to estimate the expenses for the contract may be impaired. If management's ability to estimate the expenses for the contract is impaired the contract should be accounted for as a zero profit contract until such time as management can make reasonable expense estimates. h. Obtain a detail of billings in the current year (i.e. billings by month). On a sample basis, obtain the detailed calculation of a billing amount (the actual invoice may suffice if it contains sufficient detail) and: * verify the pricing of each element on the bill by comparison to rate schedules in the contract, * verify the volume of each element, if a volume based billing, by comparison to appropriate supporting documentation, and * vouch subsequent receipt of cash (accomplished by obtaining a CARMS print screen indicating payment). i. Ascertain that billings included in the contract cost model agree to the terms of the contract. Select total billing amounts for a future year and agree estimated billings and any assumptions to the terms of the contract. j. Recalculate current period revenue under the POC method of revenue recognition using the cost incurred during the year as a percentage of total estimated contract costs multiplied by total estimated contract revenues. k. Determine that at no point in the life of the contract does unbilled revenue exceed the termination for convenience fees that are payable at that point in time as set forth in the contract. l. Determine that the account is appropriately updating the contract or POC model on an annual basis or when underlying assumptions change. 8. Analytically review the quarterly balance sheet for any unusual fluctuations and investigate. Consider the following: a. Recalculate the unbilled receivable balance by calculating the difference between the total contract revenue recognized to date and the total contract billings to date. b. Verify validity of accrued liabilities. Obtain a detailed listing of accrued liabilities with descriptions of each item accrued. On a test basis, vouch amounts to supporting documentation. Pay particular attention to subjective "general" or "other" accruals and whether they are recorded in the proper period. c. Review prepaid expenses. On a sample basis (if significant) vouch to supporting documentation to determine that the items are properly classified as prepaid and that they are being amortized correctly. d. Review the contracts aged accounts receivable trial balance. Get explanations for all past due invoices. These should be considered for possible contract problems and the implication that could have for any unbilled receivable collectability. e. If the contract has been terminated, perform the following: * Review the updated POS or POC model to insure that it reflects the termination of the contract. * Review the model's underlying assumptions for reasonableness. * Verify estimated billings during the termination period by referencing the appropriate provisions of the contract or by obtaining the termination agreement, if applicable. * Review the balance sheet and obtain an understanding of how the assets will be recovered, especially unbilled receivables and fixed assets. Insure that all assets have been written down to their net realizable value.

POC Contract Questionnaire General 1. Contract Name: 2. Industry: 3. Location of Contract: 4. Contract Term: * Start * Expiration 5. Contract Value: * Estimated total revenues at inception: * Estimated total expenses at inception:

* Most current total revenue estimate: * Most current total expense estimate: 6. Contract Revenues and Expenses: * Contract revenues to date as of _______: * Contract expenses to date as of _______: 7. Provide a description of the contract, including: * Summary of services provided * Significant contract segments * Describe any unusual clauses in the contract 8. Provide the name and phone number of the person that completed this questionnaire. 9. Please provide a statement that the unit controller has reviewed this questionnaire and has approved all of the responses. Provide the name and phone number of the unit controller. Customer Relations 10. What is the current status of the customer relationship and how has the relationship evolved since the inception of the contract? 11. Please list open issues and disputes with the customer which are currently being discussed. Please provide a description of the issue, an estimate of any financial risk associated with the issue (best case, worst case and most likely case) and an estimate of when the issue would be resolved. 12. Are there currently any discussions with the customer to re-negotiate any terms of the contract? If so, describe the customer's demands, Our position, and management's estimates of the most likely outcome (including the impact on the contract billings and expenses). 13. Describe the nature of any penalties for failure to perform under the provisions of the contact, including whether any conditions exist which have resulted in, or could result in, the assessment of such penalties. Income Statement 14. Provide account income statements for the last four completed quarters and a current YTD income statement. Provide explanations of significant fluctuations from quarter to quarter. Revenue Recognition 15. Describe in detail the method of revenue recognition selected for this contract and how the method selected is in accordance with the revenue recognition policy. 16. Describe the process of updating the percentage of completion cost model for this contract. Document who is responsible for performing the updates, how often the updates occur, and who within the contract group reviews and approves the models. 17. Include the most current percentage of completion cost model for the contract at the lowest level of detail that exists (i.e. if the contract is managed by separate categories of service, provide a model for each category and a consolidated model). The model and supporting assumptions should be detailed enough to indicate the following: * Detailed components of billings and expenses (should be same format as the P&L that is provided). * Billings, expenses, and man months by year from inception through the end of the contract. * Detailed assumptions used in deriving estimated billings and expenses (e.g. completion of milestones, CPI index, estimated growth, etc.). 18. Reconcile the most recently updated percentage of completion model with the previous model. The reconciliation should identify each significant adjustment made to the previous model, a description of the adjustment, and event that occurred to trigger the change. Additional items to consider are: * Are significant changes in aggregate contract price or costs to complete attributable to specific changes in the contract since its inception or solely revisions of estimates? * Explain any significant contract modifications or events that affect the long-term profitability of the contract (include copies of amendments). * Will additional revenue be received in connection with any modifications or changes in the level of services? 19. Utilizing the attached spreadsheet, provide a calculation of unbilled/deferred revenue and revenue recognition as of the most recent month end. Balance Sheet 20. Provide account balance sheets for the last four quarters and a current balance sheet. Provide explanations of significant fluctuations from quarter to quarter. 21. Provide an account receivable aging for the customer. * Have any reserves for receivables less than 90 days past due been made?

* Have any reserves for receivables greater than 90 days past due been made? * Has the customer been making payments in a timely manner? If not, explain why. * Explain any significant short pays that have occurred since December 31, 1998. 22. Are the termination penalties expected to fully cover our net asset exposure (including unbilled revenue) at any point during the contract, assuming termination for convenience by the customer? Provide an analysis of net assets and the termination penalty amounts over the life of the contract to support your response. 23. Detail any amount of deferred "start up costs" by type (including migration costs, employee transition costs, etc.). Explain the components of each capitalized amount and the period over which it is being amortized.

24. Describe any investments (i.e. common or preferred stock, leases, fixed asset purchases, contract concessions) in customer or related party as of the most recent quarter or month end. Internal Controls 25. Describe the oversight controls that are in place to ensure the proper matching of costs with revenues and the accounting for cost overruns and the effect on revenue recognition. 26. Who is responsible for reviewing actual revenues and expenses and how often does this review occur? 27. Describe the types of reports utilized by management to evaluate and monitor the progress/performance of the contract. Provide copies of the most recent reports. Billings 28. Describe how each significant contract component is billed (e.g. monthly fee based on contract, attainment of milestones, based on transaction volumes, fixed fee adjusted for volume etc..). Also provide support for the revenue projections made in the cost model (volume projections information received from client, historical trends, contract references, etc..). 29. Provide a detailed listing of YTD contract billings by invoice.

Please contact ______________, at "Phone Number", if you need any clarification of any of the above items in order to provide a response.

As - Billed Contract Questionnaire General 1. Contract Name: 2. Industry: 3. Location of contract: 4. Contract Term: * Start * Expiration 5. Contract Value: * Estimated total revenues at inception: * Estimated total expenses at inception: * Most current total revenue estimate: * Most current total expense estimate: 6. Contract Revenues and Expenses: * Contract revenues to date as of _______: * Contract expenses to date as of _______: 7. Provide a description of the contract, including: * Summary of services provided * Significant contract segments * Describe any unusual clauses in the contract 8. Provide the name and phone number of the person that completed this questionnaire. 9. Please provide a statement that the unit controller has reviewed this questionnaire and has approved all of the responses. Provide the name and phone number of the unit controller.

Customer Relations 10. What is the current status of the customer relationship and how has the relationship evolved since the inception of the contract? 11. Please list open issues and disputes with the customer which are currently being discussed. Please provide a description of the issue, an estimate of any financial risk associated with the issue (best case, worst case and most likely case) and an estimate of when the issue would be resolved. 12. Are there currently any discussions with the customer to re-negotiate any terms of the contract? If so, describe the customer's demands, our position, and management's estimates of the most likely outcome (including the impact on the contract billings and expenses). 13. Describe the nature of any penalties for failure to perform under the provisions of the contact, including whether any conditions exist which have resulted in, or could result in, the assessment of such penalties. Income Statement 14. Provide account income statements for the last four completed quarters and a current YTD income statement. Provide explanations of significant fluctuations from quarter to quarter. Revenue Recognition 15. Describe in detail the method of revenue recognition selected for this contract and how the method selected is in accordance with the revenue recognition policy (i.e. why was percentage of completion method not appropriate). 16. Describe the process of forecasting future billings and expenses for this contract. Document who is responsible for performing the updates, how often the updates occur and who within the contract group reviews and approves the forecasts. 17. Include the most current estimate of all future billings and expenses by year (an updated version of the Point of Sale model based on current expectations). 18. Have significant changes been made to the account's billing and expense forecast during the past year. Additional items to consider are: * Are significant changes in aggregate contract price or costs to complete attributable to specific changes in the contract since its inception or solely revisions of estimates? * Explain any significant contract modifications or events that affect the long-term profitability of the contract (include copies of amendments). * Will additional revenue be received in connection with any modifications or changes in the level of services? Balance Sheet 19. Provide account balance sheets for the last four quarters and a current balance sheet. Provide explanations of significant fluctuations from quarter to quarter. 20. Provide an account receivable aging for the customer. * Have any reserves for receivables less than 90 days past due been made? * Have any reserves for receivables greater than 90 days past due been made? * Has the customer been making payments in a timely manner? If not, explain why. * Explain any significant short pays that have occurred since December 31, 1998. 21. Are the termination penalties expected to fully cover our net assets at any point in time during the contract, assuming termination for convenience by the customer? Provide an analysis of net assets and the termination penalty amounts over the life of the contract to support your response. 22. Detail any amount of deferred "start up costs" by type (including migration costs, employee transition costs, etc.). Explain the components of each capitalized amount and the period over which it is being amortized. 23. Describe any investments (i.e. common or preferred stock, leases, fixed asset purchases, contract concessions, etc.) in customer or related party as of the most recent quarter or month end. Internal Controls 24. Describe the oversight controls that are in place to ensure the proper matching of costs with revenues and the accounting for cost overruns and the effect on revenue recognition. 25. Who is responsible for reviewing actual revenues and expenses and how often does this review occur? 26. Describe the types of reports utilized by management to evaluate and monitor the progress/performance of the contract. Provide copies of the most recent reports. Billings

27. Describe how each significant contract component is billed (e.g. monthly fee based on contract, attainment of milestones, based on transaction volumes, fixed fee adjusted for volume etc..). Also provide support for the revenue projections made in the cost model (volume projections information received from client, historical trends, contract references, etc..). 28. Provide a detailed listing of YTD contract billings by invoice.

Please contact ______________, at "Phone Number", if you need any clarification of any of the above items in order to provide a response.