Please help with three case questions! Thank you!!

The case questions are from auditing class

ACC 362 Case 3 Going Concern Designations and GAAP versus Non-GAAP Earnings Metrics . INTRODUCTION Y ou have recently been assigned to HT Company as a staff auditor. HT is a technology company that began a few years prior to the dot-com debacle and operates in a very competitive environment. The senior on the job has asked you to provide an initial analysis of whether HT should be classified as a going concern and to identify potential audit issues associated with non-GAAP earnings. Since this is a new assignment, you set out to build your background on HT's industry, the history of the company and their product and service lines, and their overall competitive position in the industry. Industry Background HT Company operates in a technology niche that helps companies manage how they spend money on their business. In the last decade, technology-based solutions have emerged to help companies increase the efficiency of the procurement and cash management processes and, as a result, more effectively manage their spend (i.e., operating expenditures). These solutions allow organizations to automate critical tasks such as identifying global suppliers, sourcing goods and services, negotiating and managing contracts, processing invoices and payments, and managing trading relationships. Procurement organizations were among the first to embrace spend management solutions as a way to achieve corporate savings targets. Today, finance departments are leveraging these solutions to drive improved cost management, business unit decision making and planning, budgeting, forecasting, and cash and working capital management. Legal departments are implementing them to more effectively author and manage contracts, and IT departments are deploying them to enhance the value of existing systems and increase returns on investment. Overview of Company In its 10-K, HT describes itself as the leading provider of on-demand spend management solutions, which are ways of monitoring operating expenditures such as raw materials, legal, administrative, etc. Its mission is to transform the way companies of all sizes, industries, and geographies operate by delivering software, service, and network solutions that enable them to holistically source, contract, procure, pay, manage, and analyze their spending and supplier relationships. Delivered on demand, its enterprise-class offerings empower companies to achieve greater control of their operating expenditures and to drive continuous improvements in financial t e and supply chain performance. The company claims that HT Spend Management solutions are 1 easy to use, cost effective, and quick to deploy and integrate with enterprise resource planning (''ERP'') and other software systems. More than 1,000 companies, including more than half of the 2011 Fortune 500 companies, use HT solutions to manage their operating expenditures, from sourcing and orders through invoicing and payment. HT was incorporated in Delaware in September 1996 and went public in 1999. The company's stock price moved from $944.30 per share on August 1, 2000, to $99.00 per share on February 1, 2001, and settled at $13.68 per share on August 1, 2001. This represented a 98.5 percent reduction in price over a one-year period, while the founders took out a considerable amount of money from stock sales over a two-year period prior to the stock's collapse. This resulted in a Securities and Exchange Commission (SEC) investigation and the resignation of the CEO and chairman of the board, along with most of the other board members. The newly hired CFO became CEO and has run the company successfully for the past ten years. Sourcing and Procurement Software Market In a 2011 Supply Management Market Sizing Report, AMR Research, a third-party research firm, projected the spend management market to grow at 10 percent Compound Annual Growth Rate (''CAGR''), becoming a $4.3 billion market in 2015 (i.e., $4.3 billion in revenues). Further, it noted that the highest growth segments within the spend management market over the next five years are projected to be in areas in which HT participates (CAGR in these areas is predicted to be between 10-11 percent). Contract management is another area that HT is expected to be involved with, and this area is also expected to grow substantially during 2012 and 2013. Competition You recognize that the market for spend management applications is highly competitive, rapidly evolving and fragmented and subject to changing technology and shifting customer needs. 1 Moreover, the following description in HT's preliminary 10-K makes you feel somewhat uneasy: Our principal direct competition comes from ERP vendors whose software is installed by customers directly. We also compete with specialty vendors that offer their software on a hosted basis or under a perpetual license. In our services business, we compete with several large and regional service providers. We anticipate additional competition from other established and emerging companies as the spend management market continues to expand. Our current principal competitors include: Enterprise software application vendors, including SAP AG and Oracle; Smaller specialty vendors, including Emptoris, BravoSolution, Zycus, and American Express S2S; Smaller niche SaaS vendors, including Perfect Commerce, cc-Hubwoo, Ketera Technologies, and Iasta; and Service providers, including A.T. Kearney and McKinsey & Company. We believe the principal competitive factors considered with respect to, and the relative competitive standing of, our spend management software solutions are: Interoperability with existing commonly used ERP systems; Ease of use and rates of user adoption; 2 Price and demonstrable cost-effective benefits for customers; Performance, security, scalability, flexibility, and reliability of the software; Vendor reputation and referenceable customers; Quality of customer support; and Financial stability of the vendor. Many of our current and potential competitors, such as ERP software vendors, including Oracle and SAP, have longer operating histories, greater name recognition, larger marketing budgets and significantly greater resources, and a larger installed base of customers than we do. They may be able to devote greater resources to the development, promotion, and sale of their products than we can to ours, which can enable them to respond more quickly to new technology, introduce new spend management modules, and respond to changes in customer needs. In addition, many of our competitors have well- established relationships with our current and potential customers and have extensive knowledge of our industry. In the past, we have lost potential customers to competitors for various reasons, including lower prices and other incentives not matched by us. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs and achieve greater market acceptance. The industry has experienced consolidation, with both larger and smaller competitors acquiring companies to broaden their offerings or increase scale. As a result, we may not be able to successfully compete against our current and future competitors. HT's GAAP Financial Performance Over the past few years, HT Company has experienced strong growth in revenue from its existing product lines (i.e., particularly, the recurring high growth revenue from cloud computingbased subscriptions has increased 31 percent from 2010 to 2011), but has been unable to generate positive income from operations. In fact, during fiscal year 2011, its overall revenue increased 8 percent while, at the same time, its net loss before income taxes increased from $13 million (in 2010) to over $40 million (in 2011). However, HT maintained a significant cash balance, experienced strong cash flows over this two-year period, and enjoyed limited leverage (see Appendix A). Rationale for Reporting Non-GAAP Earnings HT's financial performance (as viewed from a GAAP income statement perspective) is less than impressive. Over the years, however, HT has emphasized the importance of non-GAAP earnings, especially to investors. As often discussed by HT and the Street, the basic argument for reporting non-GAAP earnings is that these numbers more accurately capture financial measures that are comparable across years and across firms and that will impact future operations. NonGAAP earnings are often referred to in press releases. The non-GAAP financial measures disclosed in Company press releases are thought to be used by boards of directors and senior management teams to evaluate operating performance. Non- GAAP adjustments represent certain income statement items that are non-recurring and/or non- cash, although not every adjustment fits into these two categories. In addition, the use of a particular non-GAAP adjustment may differ based on the type of analysis. For example, investors may use certain non-GAAP adjustments for valuation purposes (i.e., as proxies for recurring cash flows) while auditors may use different non-GAAP adjustments for going concern assessments. As a result, the non-GAAP adjustments that are arrived at by an investor 3 may differ from the non-GAAP adjustments that are arrived at by an auditor. In the case of HT, although it had three years of GAAP losses, the firm's stock price increased from around $7 to $18 over this same period. This raises the issue that non-GAAP earnings could have an important impact on company valuations. See Appendix B for HT's non-GAAP adjustments. Going Concern Provisions The going concern assumption relates to the entity's inability to continue to meet its obligations as they become due without substantial changes to their operations (i.e., disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations, or similar actions). The time period generally used for measuring a going concern is not to exceed one year beyond the date of the financial statements being audited. Once the auditors believe there is substantial doubt about the entity's ability to continue as a going concern, they should obtain information about management's plans to mitigate the effect of such conditions or events, and assess the likelihood that such plans can be effectively implemented. The current audit guidelines for determining a going concern are presented in detail in Appendix C. This information on the competitive risk faced by HT, its net losses over the past few years, its positive non-GAAP earnings over this same time period, and the role of non-GAAP earnings in general has raised the issue of a going concern for the audit team. In addition, you recognize that the audit is targeted at GAAP and that there is no requirement to audit non-GAAP earnings (however, the audit of non-GAAP earnings is under review by the PCAOB). CASE QUESTIONS 1. (a) Should HT's opinion contain a going concern para graph why or why not? Use Appendices A and B to support your answer. Also, specify the relevant provisions of Appendix C in your response. (b) Identify key ratios or measures derived from the financial statements that: Support your position regarding a going concern. Do not support your conclusion regarding a going concern. C o n s i d e r, a t a m i n i m u m , t h e f o l l o w i n g r a t i o s / m e a s u r e s : Net income or loss Stockholders' equity or deficit Net cash provided/used by operating activities Current ratio (current assets/current liabilities) LT Debt to total assets (LT Debt/Total assets) 2. As the staff auditor examining this issue, your audit team has asked you to provide brief summaries about the following with regard to non-GAAP earnings (see Appendix B) (Refer to Skadden document The Use of Non-GAAP Financial Measures - A Disclosure Guide) You may wish to consider other sources of information on the subject from your own research: 4 (a) In general, why do firms report non-GAAP earnings? In general, are certain components of non-GAAP earnings more appropriate t h a n o t h e r s for use in considering a going concern decision. If so, which components would be appropriate to consider? (b) 3. Review the non-GAAP adjustments listed for this company in Appendix B. (a) Put yourself in the position of a company spokesperson. Explain a rationale that the company would communicate to the investment community that supports the use of these specific adjustments. (b) Now put yourself in the position of the staff auditor (Q1 and Q2). Are there characteristics with some of these adjustments that were more important when finalizing this going concern decision for HT? 5 APPENDIX A Financial Statements 6 HT, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) Unaudited September 30, 2011 ASSETS Current assets: Cash and cash equivalents Marketable securities Restricted cash Accounts receivable, net of allowance for doubtful accounts of $1,938 and $1,973 in 2008 and 2007, respectively Prepaid expenses and other current assets Total current assets Property and equipment, net Long-term investments Restricted cash, less current portion Goodwill Other intangible assets, net Other assets Total assets LIABil..ITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable Accrued compensation and related liabilities Accrued liabilities Restructuring obligations Deferred revenue Deferred income-Softbank $ 2010 $ 64,377 87,850 861 30,416 $ $ Total current liabilities Deferred rent obligations Restructuring obligations, less current portion Deferred revenue, less current portion Other liabilities Total liabilities Stockholders' equity: Convertible preferred stock, $.002 par value; 20,000 shares authorized; no shares issued and outstanding Common stock, $.002 par value; 1,500,000 shares authorized; 86,928 and 78,628 shares issued and outstanding as of September 30, 2008 and 2007, respectively Additional paid-in capital Accumulated other comprehensive (loss) income Accumulated deficit Total stockholders' equity Total liabilities and stockholders' equity 91,144 September 30, 30,587 8,252 129,813 20,762 21,551 31,123 426,832 25,163 31590 658,834 11,280 194,955 21,242 8,450 30,660 342,406 10,984 41069 612,765 12,812 22,554 16,461 20,921 100,295 $ $ 11,426 25,402 19,925 20,018 79,916 594 157,281 23,759 54,711 8,313 173,043 19,083 43,177 6,716 6,246 248,265 183 $ 244,064 165 5,411,844 -3,249 -4,998,209 410,569 658,834 5,321,393 1,168 -4,954,024 368,701 $ 612,765 HT, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousand8) Year Ended September 30, 2011 Operating activities: Net loss Adjustments to reconcile net loss to net cash provided by operating activities: Provisions for (recovery of) doubtful accounts Depreciation and amortization Stock-based compensation Restructuring Realized gains--currency translation adjustment Impairment of equity investments Changes in operating assets and liabilities: Accounts receivable Prepaid expenses and other assets Accounts payable Accrued compensation and related liabilities Accrued liabilities Deferred revenue Deferred income--Softbank Restructuring obligations Net cash provided by operating activities Investing activities: Cash paid for acquisitions, net of cash acquired Purchases of property and equipment Proceeds from maturities and sales of investments Purchases of investments Allocation from restricted cash, net Net cash provided by (used in) investing activities Financing activities: Proceeds from issuance of common stock Repurchase of common stock Net cash (used in) provided by financing activities Effect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Supplemental disclosures of cash flow information: Net cash paid for income taxes $ --43,115 2010 $ 2009 -15,726 $ -280 22,689 34,071 --4,404 -2,756 531 24,044 42,902 10,613 -50,191 138 24,519 43,286 27,637 156 3,789 6,245 1,286 -3,871 -8,310 13,921 -24,772 22,671 2,941 -992 1,070 -527 -3,732 19,269 -14,242 -19,979 17,402 10,600 -822 744 -5,620 -3,220 8,610 -14,264 -17,908 23,665 -58,420 -8,040 102,851 -31,256 1,073 6,208 -7,781 153,011 -158,740 1,922 -11,588 -5,339 127,765 -162,825 1,496 -38,903 6,714 -7,563 -849 6,899 -3,736 3,163 8,553 -3,291 5 63 -1,261 803 617 26,768 9,780 -9,358 -594 $ 64,377 91,144 $ 54,597 64277 $ 63,954 54,597 $ 1,907 $ 2,584 $ 1,592 APPENDIX B HT 2011 Reconciliation of GAAP to Non-GAAP Earnings Preliminary Year Ended Sept. 30, 2011 Net income (loss) reconciliation: GAAP net loss (1) Purchase accounting adjustment (2) Amortization of intangible assets (3) Stock-based compensation (4) Restructuring and integration (5) Litigation provision Non-GAAP net income ($41,062) 5,007 14,996 40,859 10,108 5,900 $35,808 Notes Regarding the Above Adjustments (1) Purchase Accounting Adjustment: When an acquisition occurs in the software industry, GAAP requires the acquirer to record deferred revenue at cost. The above adjustment simply adds an additional amount of revenue that would have been recorded had the companies been stand-alone or combined for the entire period. (2) Amortization of Intangible Assets: In accordance with GAAP, HT amortizes intangible assets acquired in connection with acquisitions. HT excludes these amortization costs in non-GAAP financial measures. (3) Stock-Based Compensation: HT excludes stock-based compensation expense in our non-GAAP measures. Stock- based compensation includes stock options, stock granted to employees, and non-executive directors in our non- GAAP financial measures. (4) Restructuring and Integration: Restructuring costs or benefits related to lease abandonment accruals. These costs represent future cash flows associated with the abandonment of lease contracts. (5) Litigation Provision: In this case, the litigation provision was already accrued and, thus, recorded as an expense on the income statement. APPENDIX C Current Auditing Guidelines Dealing with a Going Concern (Supersedes Section 340) Source: SAS No. 59; SAS No. 64; SAS No. 77; SAS No. 96. See Section 9341 for interpretations of this section. Effective for audits of financial statements for periods beginning on or after January 1, 1989, unless otherwise indicated. .01 This section provides guidance to the auditor in conducting an audit of financial statements in accordance with generally accepted auditing standards with respect to evaluating whether there is substantial doubt about the entity's ability to continue as a fn1fn2 going concern. Continuation of an entity as a going concern is assumed in financial reporting in the absence of significant information to the contrary. Ordinarily, information that significantly contradicts the going concern assumption relates to the entity's inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations, or similar actions. THE AUDITOR'S RESPONSIBILITY . 02 [The following paragraph is effective for audits of fiscal years beginning on or after December 15, 2010. See PCAOB Release No. 2010-004 (http://pcaobus.org/Rules/ Rulemaking/Docket%20026/Release_2010 -004_Risk_Assessment.pdf ). For audits of fiscal years beginning before December 15, 2010 (see: http://pcaobus.org/Standards/ Auditing/Pages/AU341_02a.aspx).] The auditor has a responsibility to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited (hereinafter referred to as a reasonable period of time). The auditor's evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor's report. Information about such conditions or events is obtained from the application of auditing procedures planned and performed to achieve audit objectives that are related to management's assertions embodied in the financial statements being audited, as described in Auditing Standard No. 15, Audit Evidence. . 03 The auditor should evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time in the following manner: a. The auditor considers whether the results of his procedures performed in planning, gathering evidential matter relative to the various audit objectives, and completing the audit identify conditions and events that, when considered in the aggregate, indicate there could be substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. It may be necessary to obtain additional information about such conditions and events, as well as the appropriate evidential matter to support information that mitigates the auditor's doubt. b. If the auditor believes there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, he should (1) obtain information about management's plans that are intended to mitigate the effect of such conditions or events, and (2) assess the likelihood that such plans can be effectively implemented. c. After the auditor has evaluated management's plans, he concludes whether he has substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. If the auditor concludes there is substantial doubt, he should (1) consider the adequacy of disclosure about the entity's possible inability to continue as a going concern for a reasonable period of time, and (2) include an explanatory paragraph (following the opinion paragraph) in his audit report to reflect his conclusion. If the auditor concludes that substantial doubt does not exist, he should consider the need for disclosure. . 04 d. e. The auditor is not responsible for predicting future conditions or events. The fact that the entity may cease to exist as a going concern subsequent to receiving a report from the auditor that does not refer to substantial doubt, even within one year following the date of the financial statements, does not, in itself, indicate inadequate performance by the auditor. Accordingly, the absence of reference to substantial doubt in an auditor's report should not be viewed as providing assurance as to an entity's ability to continue as a going concern. f