ABC, INC.
A Comprehensive Decision Based Case,
3rd Edition, 2015
ISBN: 9780986165832 support@capstoneeducationalpublishing.com
No Refunds After 30 Days of Downloading File TABLE OF CONTENTS 1.
2.
3.
4.
5.
6. Financial Statements and Notes
Additional Company and Industry Information
General Risk Management Questionnaire and Problem
Control Environment Questionnaire and Problem
Client Acceptance and Planning Problem
Statistical Auditing Problems
a. Attribute Sampling Problem 1
b. Attribute Sampling Problem 2
c. Probability Proportionate to Size Problem
d. Variables Sampling Problem
7. Internal Control Problems
a. Internal Control Questionnaire and Assertions Problem
b. Cash Handling Questionnaire Problem
c. Receivables Questionnaire Problem
d. Inventory Questionnaire Problem
e. Personnel and Payroll Questionnaire Problem
f. Internal control over purchasing Problem
g. Internal control over sales Problem
8. Substantive Testing Problems
a. Cash Problem
b. Accounts receivable Problem
c. Investment Objectives Problem
d. Current liabilities Problem
e. Long-term liabilities Problem
9. Completing the Audit Problems
10. Report Writing Problems Section 1
FINANCIAL STATEMENTS AND NOTES ABC INC SIC Code 7372 - Prepackaged Software
Industry Software & Programming Sector Technology Fiscal Year 1 12/31 BUSINESS
Our Company
We provide on-demand software solutions and services for the residential mortgage industry in the United States . Our mortgage
management solutions help streamline and automate the process of originating and funding new mortgage loans, thereby increasing efficiency,
improving loan quality, facilitating regulatory compliance and reducing documentation errors while providing one system of record for loans .
Our Awesome software is an end-to-end, comprehensive enterprise solution that handles most of the functions involved in running the
business of originating mortgages: customer relationship management; loan processing; underwriting; preparation of application, disclosure and
closing documents; funding and closing the loan for the borrower; compliance with regulatory and investor requirements and overall enterprise
management that provides one system of record. Delivery of our Awesome software in an on-demand Software-as-a-Service, or SaaS,
environment provides customers with the added benefits of lower up front implementation costs and reduced need for an infrastructure of
servers, storage and network devices as well as providing access to the most current release of an application, periodic upgrades and regulatory
updates. We also host the ABC Network , a proprietary electronic platform that allows Awesome users to conduct electronic business
transactions with investors and settlement service providers they work with in order to process and fund loans. As of December 31, 2013 , the
ABC Network electronically connects the approximately 92,000 mortgage professionals using Awesome to the broad array of mortgage
lenders, investors and third-party service providers integral to the origination and funding of residential mortgages.
For mortgage originators, Awesome is a comprehensive operating system that handles key business and management functions involved
in running a mortgage origination business. Mortgage originators use Awesome as a single tool for loan processing, marketing, customer
communication and to interact electronically with lenders, investors and service providers over the ABC Network. We also offer Awesome users a
variety of other on-demand software services, including : Awesome Docs Solution , which automatically prepares the disclosure and closing
documents necessary to fund a mortgage ; Awesome CenterWise , a bundled offering of electronic document management, or EDM , and
websites used for customer relationship management; Total Quality Loan, or TQL , which offers a suite of fraud detection, valuation,
validation and risk analysis services ; Awesome Compliance Service , which automatically checks for compliance with federal, state and local
regulations throughout the origination process ; tax transcript services which provide income verification capability; services for ordering and
managing appraisals; Awesome CRM , a suite of tools for managing contacts, leads and marketing campaigns; Awesome Product and Pricing
Service , which allows Awesome users to compare loans offered by different lenders and investors to determine appropriate mortgage programs
available to a particular borrower ; and Awesome Flood Service , which allows Awesome users to order and transfer flood zone certifications.
For the lenders, investors and service providers on the ABC Network, we provide electronic connectivity that allows them to do
business with a significant percentage of the mortgage origination professionals in the United States.
Mortgage originators purchase Awesome software as a service, paying either recurring subscription fees or monthly fees based on the
number of licensed users and mortgages funded. Our additional services are paid on a subscription or transaction basis. Lenders and service
providers participating in the ABC Network also pay us fees, generally on a per transaction basis, for business received from Awesome
users. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements
and the notes thereto included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements
that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.
Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K,
particularly in “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”
Overview
We provide on-demand software solutions and services for the residential mortgage industry in the United States. Our mortgage
management solutions help streamline and automate the process of originating and funding new mortgage loans, thereby increasing efficiency,
improving loan quality, facilitating regulatory compliance and reducing documentation errors while providing one system of record for loans .
Mortgage originators use our Awesome software, a comprehensive operating system that handles key business and management functions
involved in running a mortgage origination business. Mortgage originators use Awesome as a single tool for loan processing, marketing,
customer communication and to interact electronically with lenders, investors and service providers over the ABC Network. Our software also 2 enables enforcement of rules and business practices designed to ensure loan quality, adherence to processing standards and regulatory
compliance.
We also offer Awesome users a variety of other on-demand software services, including : Awesome Docs Solution, which automatically
prepares the disclosure and closing documents necessary to fund a mortgage ; Awesome CenterWise, a bundled offering of EDM and websites
used for customer relationship management; TQL , which offers a suite of fraud detection, valuation, validation and risk analysis services using
streamlined workflows and processing rules; Awesome Compliance Service, which automatically checks for compliance with federal, state and
local regulations throughout the origination process ; tax transcript services which provide income verification capability to our customers;
Awesome Product and Pricing Service, which allows Awesome users to compare loans offered by different lenders and investors to determine
appropriate mortgage programs available to a particular borrower and Awesome Flood Service, which allows Awesome users to order and
transfer flood zone certifications. By the nature of our on-demand service, even with our robust security monitoring and detection systems, we
cannot guarantee that our security measures will prevent security breaches and we may need to expend significant resources to protect against
and remedy any potential security breaches and their consequences.
The ABC Network electronically connects the approximately 92,000 mortgage professionals using Awesome to the broad array of
mortgage lenders, investors and third-party service providers integral to the origination and funding of residential mortgages. During the
mortgage origination process, mortgage originators may order various services through the ABC Network , including credit reports, product
eligibility and pricing services, automated underwriting services, appraisals, title reports, insurance, flood certifications and flood insurance,
compliance reviews, fraud detection, document preparation and verification of income, identity and employment. Mortgage originators can also
initiate secure data transmission to and from lenders and investors.
We were formed as a California corporation in 1997 and reincorporated in Delaware in November 2009. From inception through 2000, we
developed consumer-facing websites and initial versions of our network. We launched our first transaction platform in late 2000, the present
version of which is the ABC Network .
Our revenues consist of on-demand and on-premise revenues. On-demand revenues are generated primarily from software subscriptions we
host that customers access through the Internet, including customers who pay fees based on the number of loans they fund, or success basis,
subject to monthly base fees, which we refer to as Success-Based Pricing On-demand revenues also include software services that are sold
transactionally as well as ABC Network transaction fees paid by lender-investors, service providers and certain government-sponsored
entities participating on the ABC Network . On-premise revenues are generated from customer-hosted software licenses and
implementations, training and maintenance services. For further discussion of the sources of our revenue and our revenue recognition policy,
please see our Critical Accounting Policies and Estimates below.
Our on-demand revenues generally track the seasonality of the residential mortgage industry, typically, but not always, with increased
activity in the second and third quarters and reduced activity in the first and fourth quarters as home buyers tend to purchase their homes during
the spring and summer in order to move to a new home before the start of the school year. Mortgage volumes are also impacted by other factors
such as interest rate fluctuations, home sale activity and general economic conditions, which can lead to departures from the typical seasonal
pattern. For example, increases in mortgage interest rates could reduce the volume of new mortgages originated and, in particular, the volume of
mortgage refinancings. We currently estimate that approximately 30% to 40% of our revenues has some sensitivity to volume. Contracted
revenues, which are not sensitive to volume, represented 57% of total revenues for the year ended December 31, 2013.
We are investing aggressively in initiatives that we believe will help us continue to grow our business, improve our products and services
and strengthen our competitive advantage while bringing sustainable, long-term value to our customers. During 2013, we accelerated our
investments in our sales and client services capabilities, in research and development and in technology infrastructure to support our user
additions and overall business growth. These investments included expanding our talent across the organization by hiring additional personnel,
especially for our customer acquisition, client services and implementation teams and our research and development teams; developing nextgeneration products and enhancements; purchasing computer equipment; upgrading our telephony systems and building out new office facilities.
In addition to our internal initiatives, our business strategy has evolved to address recent industry trends, including:
• expected lower lending volume; • increased quality standards imposed by regulators, lenders and investors; • increased regulation affecting lenders and investors; • greater focus by our customers on operational efficiencies; and • customers adopting multi-channel strategies We are responding to these trends as follows:
Expected lower lending volume. Mortgage lending volume is expected to be lower in 2014 than in 2013 , as forecasted by Fannie Mae,
Freddie Mac and the Mortgage Bankers Association. Since late 2009, we have focused our marketing and sales efforts on our on-demand SaaS
Awesome offering, and particularly our SaaS Awesome Success-Based Pricing model, in contrast to our on-premise license model. In our on- 3 demand SaaS Awesome offering, the customer does not pay the significant up-front licensing fee associated with our license model, which we
believe is particularly attractive in the present climate of the residential mortgage origination market. Our SaaS Awesome Success-Based
Pricing model builds on this value proposition by aligning customers’ payments for our software solutions with their own receipts of revenues .
Our focus on our SaaS Awesome offering is important in light of lower lending volumes because we typically generate greater revenues per
user through our on-demand SaaS Awesome offering than through our on-premise license offering.
We are also focusing on increasing use of our ABC Network offerings and our other services, which were introduced from late 2009
through late 2011. These offerings include our TQL program, Awesome Compliance Service, Awesome Product and Pricing Service ,
Awesome Docs Solution and Awesome 4506-T Service . During 013 and 2012 , Awesome users employed the ABC Network to process on
average approximately six and five transactions per loan file, respectively . By continuing to enhance our service offerings and encouraging
providers of settlement services to deliver their services electronically through the ABC Network , we will continue to build value for ABC
Network participants while increasing the number of transactions for which the ABC Network is used.
Increased quality standards imposed by regulators, lenders and investors. Awesome is designed to automate and streamline the process
of originating mortgages to, among other things, satisfy increased quality requirements of investors. Relevant features of Awesome include
enabling customers’ management to impose processing rules and formats, and providing milestone and process reminders, automated population
of forms with accurate data, and accurate and automated transmission of loan files and data from originators to investors and lenders. Our TQL
program is designed to further enhance the quality, compliance and saleability of loans that are originated through Awesome. Additionally,
TQL is intended to reduce the opportunities for errors in the process of transferring information from originator to investor and give investors
confidence in the accuracy and regulatory compliance of the information that is underlying loan files.
In response to the increased quality standards and compliance mandates affecting the industry, we expect an increased number of
mortgage lenders to assess new platform options and replace their legacy systems. We have increased the size of our customer acquisition,
implementation and support teams by approximately 42% from December 31, 2012 to December 31, 2013 in order to address anticipated
demand for our software solutions
Increased regulation affecting lenders and investors. Regulatory reforms have significantly increased the complexity and importance of
regulatory compliance. We devote considerable resources to continually upgrading software to help customers address regulatory changes. We
offer Awesome Compliance Service, which automatically checks loan files for compliance with the myriad of federal, state and local
regulations and alerts users to possible violations of these regulations. In addition, we have a staff of attorneys and work with compliance experts
who help assure that documents prepared using our software and the processes recommended by the Awesome workflow comply with
applicable rules and regulations. We believe we are well-positioned to help our customers meet additional requirements from the Dodd-Frank
Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, that became effective in January 2014. Our ATR / QM , functionality is
designed to allow our customers to document their compliance with the CFPB ’s ATR / QM Final Rule that applies to the majority of residential
mortgage loan originations in the United States. We believe we are also well-positioned to help our customers meet future Dodd-Frank Act
requirements as they are published and become effective.
Greater focus on operational efficiencies. Mortgage originators experienced an approximately 40% increase in direct production costs per
loan between 2009 and 2011 1 , and we expect this trend to continue due to continued increased regulation and heightened quality standards. By
automating many of the functions of mortgage origination, we enable our users to comply with regulations and process quality loans more
efficiently and effectively. This reduces the cost of originating a loan and lowers the risk of buy back demands from investors resulting from
poorly originated or documented loans and/or loans that fail to comply with applicable regulations.
With an eye towards providing customers with ever-greater tools to enhance efficiency, we will continue to develop new service offerings
through the ABC Network and pursue adoption of our services through initiatives such as our TQL program. By integrating and expanding our
current and new services, we will provide a more comprehensive benefit to our users.
In addition to providing efficiency-enhancing solutions, delivery of our Awesome software in an on-demand SaaS environment provides
customers with the added benefits of lower up front implementation costs and reduced need for an infrastructure of servers, storage and network
devices as well as providing access to the most current release of an application, periodic upgrades and regulatory updates.
Customers adopting multi-channel strategies. Customers are developing multi-channel strategies beyond a single retail, correspondent or
wholesale channel in order to grow their businesses. The requirements of these different channels vary and in order to maintain a single
operating system, customers must use a robust system with customizable functionality. We continually address the changing needs of our
customers by developing and enhancing tools to allow for simplified regulatory compliance, increased availability of information, and enhanced
system functionality and performance.
Acquisition Strategy
Our industry is highly fragmented, and we believe there are strategic opportunities available to acquire competing software companies or
software providers that offer related mortgage origination functionality that will complement and increase the attractiveness of Awesome For
example, in January 2014, we acquired substantially all the assets of MortgageCEO , 4 This page left intentionally blank
This 5 The following table shows these operating metrics as of and for the years ended December 31, 2013, 2012 and 2011:
Year ended December 31,
2013 Revenues (in thousands):
Total revenues
Total contracted revenues
Total SaaS Awesome revenues
Users at end of period:
Contracted SaaS users
Active Awesome users
Active SaaS Awesome users
Active SaaS Awesome users as a percentage of active Awesome
users
Active SaaS Awesome users as a percentage of contracted SaaS users
Average users during period:
Active Awesome users
Active SaaS Awesome users
Active SaaS Awesome users as a percentage of active Awesome
users
Revenue per average user during period:
Revenue per average active Awesome user
SaaS Awesome revenue per average active SaaS Awesome user $
$
$ 2012 128,481
72,967
73,698 $
$
$ 95,044
92,161
63,695 $
$
$ 45%
68% 63,993
33,203 64% 51,455
19,330 52%
$
$ 1,592
1,444 55,494
30,312
19,803
35,745
53,767
24,252 56%
69% 87,276
55,421 1,472
1,330 101,845
48,768
47,940
60,187
73,687
41,458 69%
67% $
$ 2011 38%
$
$ 1,078
1,024 Basis of Presentation
General
Our consolidated financial statements include the accounts of ABC , Inc. and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated upon consolidation.
Revenue Recognition
We generate revenue primarily from transaction-based fees and fees for software and related services. Our software can be accessed either
through a company-hosted subscription or a customer-hosted license. Accordingly, our revenues are now described as on-demand and onpremise revenues. Sales taxes assessed by governmental authorities are excluded from revenue.
On-demand Revenues
On-demand revenues are revenues generated from company-hosted software subscriptions that customers access through the Internet as
well as revenues from a small number of customers that have opted to self-host a portion of the software but pay fees based on a per closed loan,
or success, basis subject to monthly base fees, which we refer to as Success-Based Pricing. On-demand revenues are also comprised of software
services sold transactionally and ABC Network transaction fees.
On-premise Revenues
On-premise revenues are revenues generated from maintenance services, sales of customer-hosted software licenses (except for customerhosted Success-Based Pricing revenues, which are included in on-demand revenues described above), and professional services, which include
consulting, implementation and training services.
Cost of Revenues and Operating Expenses
Cost of Revenues
Our cost of revenues consists primarily of: salaries and benefits, including stock-based compensation; expenses for document preparation,
income verification and compliance services; customer support; data centers; depreciation on computer equipment used in supporting the ABC
Network , SaaS Awesome and Awesome CenterWise offerings; amortization of acquired intangible assets such as developed technology and
trade names; professional services associated with implementation of our software; and allocated facilities costs. We expect that our cost of 6 revenues will continue to increase in absolute dollars as our revenues increase, as we make additional investments in our technology
infrastructure and as we continue to hire additional personnel in our implementation and customer support departments to support new
customers.
Sales and Marketing
Our sales and marketing expenses consist primarily of: salaries, benefits and incentive compensation, including stock-based compensation
and commissions; allocated facilities costs; expenses for trade shows, public relations and other promotional and marketing activities; expenses
for travel and entertainment; and amortization of acquired intangible assets such as customer lists and contracts. We expect that our sales and
marketing expense will continue to increase as we continue to hire additional sales personnel in order to address anticipated demand for our
software solutions as we expect an increased number of mortgage lenders to assess new platform options and replace their legacy systems We
also intend to increase marketing activities focused on SaaS Awesome, our ABC Network offerings and our other Awesome services.
Research and Development
Our research and development expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation; fees
to contractors engaged in the development and support of the ABC Network infrastructure, Awesome software and other products; and
allocated facilities costs. We expect that our research and development expenses will continue to increase in absolute dollars as we continue to
invest in our products and services and infrastructure, including hiring additional engineering and product development personnel.
General and Administrative
Our general and administrative expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation, for
employees involved in finance, accounting, human resources, administrative and legal roles; consulting, legal, accounting and other professional
services by third-party providers; and allocated facilities costs. We expect general and administrative expenses to continue to increase in absolute
dollars primarily due to greater amounts of stock compensation expense relating to awards granted to attract and retain the employees needed to
continue to grow our business.
Other Income (Expense), Net
Other income (expense), net consists of interest income earned on investments, cash accounts and notes receivable, offset by investment
discount amortization and imputed interest exp...

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