ACC 491 Facebook Inc Audit Considerations
ACC 491, Facebook, Inc., Audit, Considerations
General Audit Concerns
Facebook is highly complex technology company that offers software products to users, such as Facebook, Instagram, and Messenger, among others. Facebook’s main source of revenue comes from selling advertising placements to marketers. The ads that are sold are based on a number of personal data points that Facebook collects about its users. (Facebook, Inc., 2019, p. 5)
Since Facebook’s business is based on highly technical software and information technology concepts, auditors who have technical knowledge of these concepts and the technology industry will be required for the engagement. Due to the technical concepts, familiarity with Facebook’s business model, accounting methods and processes will be required.
This could take some time to adequately understand during the first audit we undertake with Facebook. However, a full financial audit of Facebook should be completed in one month, to not only provide good customer service to Facebook, but to also free up our auditors for other engagements.
General Business Concerns
Mark Zuckerberg is the Founder, Chairman and Chief Executive Officer of Facebook (Facebook, Inc., 2019). He has provided steady leadership and has been with the company since he founded it. Facebook is based in Menlo Park, California with over 35,000 employees and has users in many countries around the world. (Facebook, Inc., 2019)
Facebook operates in the technology sector, and competes with companies that also strive to acquire users so they can sell targeted advertising to companies who want to reach those users. Facebook’s main competitors are companies such as Apple, Google, Twitter and YouTube. (Facebook, Inc., 2019, p. 5)
Competition for targeted advertisements is intense, although Facebook has differentiated themselves as a robust social network, the likes of which is unique amongst their competition.Facebook has not undergone any major mergers or acquisitions in recent years to enlarge their user base, but instead they have focused on growing their business through user referrals, and marketing campaigns.
Facebook does actively sell to advertisers around the world, to gain their business. (Facebook, Inc., 2019, p. 6) Operating expenses are mostly related to operation of computer equipment, and the cost of salaries. These expenses could fluctuate with certain market conditions such as the cost of energy and computer equipment. (Facebook, Inc., 2019, p. 42)
Seasonality is not an issue in the traditional sense, although since Facebook derives its income from the activities of users, human behavior causes a type of seasonality, with more activity, and more advertising revenue coming towards the major holidays at the end of the year as the graph below indicates:
(Facebook, Inc., 2019, p. 38)
Because Facebook operates in many countries around the world, they are subject to laws and regulations regarding user data and privacy in those countries. (Facebook, Inc., 2019, p. 6) As Facebook’s power and influence grows larger, more attention will be paid to them by regulating bodies who may seek to investigate or audit data privacy practices.
Ethics and Legal Issues
Former Facebook employees compared the culture to being in a cult. This outlook contributed to the company’s well-publicized wave of scandals such as governments spreading misinformation to try to influence elections and the misuse of private user data, according to many people who worked there during this period.
Amid these scandals, Facebook’s share price fell nearly 30 percent in 2018 and nearly 40 percent since a peak in July, resulting in a loss of more than $252 billion in market capitalization (Rodriguez, 2020).
According to Kiel (2020) in January of 2020, A trial was scheduled for February, and the IRS is trying to convince a judge that it has an audit firm basis for its conclusions. For its part, Facebook has defended its actions in court filings, calling the IRS’ conclusions “arbitrary, capricious, or unreasonable.”
Facebook has paid out several settlements due to privacy breaches. The company is susceptible to lawsuits or other legal proceedings.
Regulatory and Compliance Concerns
According to “Facebook Investor Relations”(2020), Facebook Personnel are expected to act within the bounds of applicable laws, rules, and regulations of the countries where we do business. The application of these and other laws can be complex and fact dependent. Some of the compliance requirements for Facebook are: Anti-Corruption, International Trade, Lobbying and Campaign Finance and Insider Trading among others (10).
Facebook is subject to a high-level of governmental regulation due to the nature of the business. There are two regulation sanctions that could be considered for Facebook and those are: regulations as a media company or that of a publishing company.
Facebook employees are unionized. In the past, Facebook has not been complying. Facebook will have a privacy oversight board and be subject to privacy audits, while Mark Zuckerberg will be asked to personally certify privacy statements, much as corporate leaders must certify financial statements as of July 24, 2019 (Byers, 2020).
Section 2 – Analytical Procedures
Cash ratio 2.18 1.6 4.2 1.84 Quick ratio 0 0 0 0 Current ratio 4.4 9.15 7.1 4.68 Ability to Meet
Debt to equity 0.10 .37 0 .39 Times interest
29.03 15.41 55.60 15.21 Profitability
Gross profit percent 35.09 67.13 45.41 68.28 Profit margin 26.14 42.36 39.59 39.62 Return on assets 13.85 11.53 22.71 11.86 Return on common equity 18.92 16.83 26.28 17.71
(Facebook, Inc., 2020), (Twitter, Inc., 2020)
A major risk factor for Facebook is having the ability to grow and retain users, with users increasingly engaging with competitors’ products and services. Facebook’s main source of revenue is from advertisements targeting their users. Acquiring and keeping active users is critical to Facebook’s business model.
However, negative publicity about privacy breaches and data sharing could adversely impact Facebook’s revenues. Competitors of Facebook who may not have the negative media coverage about these types of issues could gain market share from Facebook.
From 2018 to 2019 there has been a notable down slope in the profit margin from 39.5 percent to 26.14 percent. As in comparison to Facebook’s competitor, Twitter, that has been able to increase in profit margin from 39.62 to 42.36 percent. Other profitability indicators have also declined for Facebook while being relatively stable for Twitter.
Gross profit percentage, return on assets and return on common equity have all declined for Facebook, while Twitter’s ratios were all very stable year over year. Revenue accounting will have to be an area of emphasis for the audit, as well as an evaluation of whether this trend will continue. Efforts should also be made to determine why Facebook’s profitability has declined in such a way.
Facebook’s short term debt paying ability ratios have decreased significantly year over year, while Twitter’s cash ratio has slightly increased and their current ratio increased significantly from 4.68 to 9.15. Facebook saw volatility with its ability to meet long term obligations, while Twitter did not.
This is an area to focus on in the audit because it appears Facebook has seen an unusual amount of activity related to its debt, especially compared to it’s competitor Twitter.
Both Facebook’s profitability and ability to repay obligations have seen declines while its competitor Twitter has seen less volatility and has even shown improvement in some areas. This should be an area of emphasis for the audit, to be able to explain the changes and offer an opinion on whether this trend is likely to continue in the future.
Section 3 – Materiality and Risk – Key Concepts
Materiality is a threshold based on an amount of an omission or misstatement at which a reasonable person who is relying on that information would be likely to be influenced by or change their decision or judgement based on. (Arens, Elder, & Beasley, 2014, p. 273)
Below the materiality threshold, any errors or misstatements are considered insignificant, because a reasonable person’s judgement would not be affected. Above the materiality threshold, any errors or misstatements would be considered significant because they would affect the judgement of a reasonable person.
For instance, a $100 thousand misstatement by Amazon would not affect the judgement of a reasonable person when reviewing their financials. However, a $100 billion misstatement would affect the decision making of a reasonable person.
Misstatements are errors that affect financial statements. They can be a result of human error, noncompliance to accounting standards, or they can be due to fraud. Misstatements can be either large in nature (material), or small in nature (immaterial), depending on the threshold for materiality.
Certain material misstatements may cause the need to restate previous years financial statements. If misstatements are found during the course of an audit, they can be corrected and new controls or policies can be put in place to attempt to prevent them from occurring again in the future.
Audit Risk is the likelihood that material misstatements may be present in financial statements after the audit is complete and a qualified opinion has been issued by the auditor. (Arens, Elder, & Beasley, 2014, p. 272) Auditing firms must identify how much audit risk they are willing to take on in an engagement, and if the risk is high, audit fees should be priced appropriately.
Auditing firms can be held liable if material misstatements or fraud exist in the financial statements and they were not uncovered during the engagement. It is important to mitigate audit risk through proper planning and execution of an audit.
The Audit Risk Model is a mathematical model that shows the amount of risk present in an audit. The components of the audit risk model are acceptable audit risk (AAR)
– the amount of risk the auditor is willing to accept that material misstatements exist, inherent risk (IR)
– the risk of material misstatements present before considering any internal controls, control risk (CR)
– the risk that internal controls would not prevent material misstatements, and planned detection risk (PDR)
– the risk that material misstatements could not be detected with the evidence gathered. The audit risk model formula is PDR = AAR/(IR x CR). (Arens, Elder, & Beasley, 2014, pp. 272-273)
Inherent Risk is the likelihood that material misstatements exist, before considering the effectiveness of internal controls. (Arens, Elder, & Beasley, 2014, p. 273) Identifying inherent risk involves the auditors identifying where material misstatements are most likely to occur.
For instance, for Facebook, there is more inherent risk for material misstatement in the advertising revenue accounts than there would be in the petty cash accounts. Because of the inherent risk in the advertising revenue accounts, these types of transactions should be understood, as well as any controls in place to prevent material misstatements from occurring. The contracts with Facebook’s advertisers should also be explored to mitigate the inherent risk in that area.
The Relationship of Risk to Audit Evidence is the fact that a random sampling of evidence may not uncover errors that exist and that could cause material misstatements. This is also known as planned detection risk. Imagine Bob gives Joe a brown paper bag of 1,000 skittles, and Bob claims that at least 95% the skittles in the bag are green.
Joe has hired you to provide assurance that Bob’s claim is true. It would not be feasible to inspect every skittle to assure that 95% percent of the skittles are green. However, you could pull a random 100 skittles out of the bag and if five or fewer are not green, you could reasonable provide assurance to Joe that Bob’s claim is true.
However, the relationship of risk to audit evidence is that the sample of 100 skittles you pulled out of the bag was not representative of the entire population of skittles, and that in reality, maybe 10% of the bag was not green, which would be a material misstatement. Sometimes a random sampling of evidence does not have errors that could cause material misstatements.
Section 4 – Audit Tests
Risk assessment procedures will be crucial to a successful engagement with Facebook, Inc. To mitigate audit risk, as well as be in compliance with auditing standards, Facebook’s business and the industry it operates in must be understood. Auditors familiar with software or information technology will be required.
Perhaps auditors with a legal background could work on the engagement as well since Facebook is subject to many laws and regulations regarding user data and privacy. For the audit itself, adequate evidence will be gathered, tested and analyzed to mitigate inherent risk. Controls will be documented and tested to mitigate control risk.
All of these risk assessment procedures are done to asses the risk of material misstatements in the financial statements. (Arens, Elder, & Beasley, 2014, p. 402)
Controls will have to be documented, understood, and tested to asses control risk. Evidence will have to be gathered to ensure the internal controls are effective and are being followed. Types of controls that can be tested are controls involving disbursements, approvals on reconciliations, and information technology controls around user data and security.
Substantive tests of transactions will be completed to ensure transactions are being properly recorded in Facebook’s general ledger accounts. Testing will be done to ensure occurrence (transactions do exist), and completeness (transactions were recorded in the appropriate time period). (Arens, Elder, & Beasley, 2014, p. 404) Some of the transactions that can be reviewed will be expense disbursements and sales revenue transactions.
Analytical procedures can be completed to save time in future engagements by having the auditors calculate certain account balances, ratios and other key metrics. If the actual numbers are within reason, many can be eliminated from the audit process or sample sizes can be reduced. (Arens, Elder, & Beasley, 2014, p. 405) However, for the first audit of Facebook, analytical procedures should not be relied on (but still could be completed), so we can get familiar with Facebook and its processes.
Tests of details of balances will be important to reduce the risk of material misstatements in the balance sheet and income statement accounts. Accounts receivable, accounts payable, revenue and expense accounts, among others will be examined to ensure the ending balances are correct. To arrive at the ending balances, the details of each account will have be reviewed and verified through the collection and testing of evidence. (Arens, Elder, & Beasley, 2014, p. 406)
Works Cited Arens, A. A., Elder, R. J., & Beasley, M. S. (2014). Auditing and Assurance Services: An Integrated Approach. Boston, MA: Pearson. Facebook, Inc. (2019, January 31). Facebook Annual Report 2018. Retrieved from Facebook – Investor Relations: https://s21.q4cdn.com/399680738/files/doc_financials/annual_reports/2018-Annual-Report.pdf Facebook, Inc. (2020, January 29).
Facebook Reports Fourth Quarter and Full Year 2019 Results. Retrieved from Facebook Investor Relations: https://investor.fb.com/investor-news/press-release-details/2020/Facebook-Reports-Fourth-Quarter-and-Full-Year-2019-Results/default.aspx Twitter, Inc. (2020, February 6).
Twitter Announces Fourth Quarter and Fiscal Year 2019 Results. Retrieved from PR Newswire: https://www.prnewswire.com/news-releases/twitter-announces-fourth-quarter-and-fiscal-year-2019-results-301000248.html Byers, D. (2020). NBC news.
Retrieved from https://www.nbcnews.com/news/all/facebook-s-ftc-settlement-points-toward-future-privacy Kiel, P. (2020). Scroll in. Retrieved from https://scroll.in/article/951276/at-the-centre-of-the-us-government-and-facebooks-tax-dispute-is-the-companys-dublin-office Rodriguez, S. (2020). NBC. Retrieved from https://www.cnbc.com/2019/01/08/facebook-culture-cult-performance-review-process-blamed.html