Accounting Issues Memos
120 Points
Overview: This project requires the preparation of accounting issues memos, using the format in the Collins text. The project is a 2-part case about a client’s concerns with respect to the application of Topic 606 revenue recognition guidance to one of its contracts. Codification citations are required and writing counts.
The first accounting issues memo is worth 70 points and is due Sunday, May 1 at 11:55 p.m. The second memo (in a modified format, see below) is due no later than Saturday, May 14 at 11:55 p.m. and is worth 50 points. Your memos should be addressed to the client. Rubrics are provided for each part.
Overview: On June 20, 2021, your public accounting firm’s account manager for Video Solutions, Inc. (VS), a new client, has asked you to prepare a memo addressing the client’s concerns about the application of revenue recognition guidance (Topic 606). The management of Video Solutions has informed you that it is about to complete negotiations with All Things Tech, Inc. (ATT) to install a customized monitoring system for the customer’s manufacturing plant. This contract will have features that are not routinely included in the contracts with its other customers.
Your client’s concerns about the application of topic 606 on revenue recognition guidance appear at the end of each part of the case.
The Case, Part 1:
VS sells sophisticated video surveillance equipment. VS sells the customized equipment and computer integration services together. It does not sell these separately. The equipment cannot operate without being fully integrated with a computer system. Significant customization is required during this integration. Other competitors could theoretically provide computer integration services, but VS does not sell its equipment separately.
The VS sales manager has notified her management that she anticipates receiving a signed contract from ATT to provide equipment and to perform computer integration services for that surveillance equipment by July 1. VS management has agreed to having everything operational for ATT within one year of the contract signing. ATT will not get control of the video surveillance equipment until the integration is completed and VS turns control of the fully operational system over to ATT. At that point, full payment of the contract price is required to be delivered to VS by ATT.
In the initial contract negotiations, the contract price with ATT was $10.1 million in cash. However, as part of the final contract negotiations, ATT agreed to give VS its old surveillance equipment in exchange for a credit of $100,000. It is expected that this old surveillance equipment will not be decommissioned until the new equipment is operational. Based on its extensive experience, VS management believes it is probable that the estimated fair value of the old equipment at the contract inception date will be $115,000.
During the negotiations, VS offered maintenance services of the equipment, after the equipment is fully operational and turned over to ATT. Prior to this contract, VS has not provided maintenance services. Initially, VS proposed the 5 years of monthly maintenance services for $350,000 total included as part of the contract price. ATT informed VS that several competitors were offering attractive pricing to obtain this maintenance work for less. In order get the maintenance work, VS agreed to providing the maintenance services for $290,000, as part of the contract price. This five-year monthly maintenance agreement will commence after the installation is completed.
Due to deep security concerns and recent losses of proprietary information, ATT also is offering a bonus to VS if the integration is completed early and VS has agreed to pay a penalty if the integration is completed late. VS has a large number of contracts with bonus characteristics similar to this proposed contract with ATT. The following is the schedule of the potential bonus or penalty. While no specific outcome is probable, VS management’s assessment of the likelihood of completing the integration in the specified time frame is based on significant historical experience with similar integration jobs.
| Completed | Bonus | Penalty | Percentage |
| 10 months | $100,000 | 17% | |
| 11 months | 50,000 | 27% | |
| 12 months | 0 | $ 0 | 46% |
| 13 months | (50,000) | 7% | |
| 14 months | (100,000) | 3% | |
| 15 months plus | (500,000) | 0% | |
| Total | 100% |
There is also a provision in the contract that ATT would receive a “discount” from the contract price of $10.1 million if ATT pays the cash component within three days of when the contract is signed, instead of paying after the system is fully operational. This “discount” is similar to that which would be reflected in a separate financing transaction if ATT accepted the financing by VS, as VS customarily offers other customers for projects whose duration is expected to be 1 year or more. VS determined a “discount” of $500,000 for this financing based on applying the typical credit rate for the equipment and integration services that would be delivered at the end of one year or more.
The VS sales manager will receive a 2% bonus based on the $10 million (after credit for equipment) contract price, payable upon receipt of a signed contract. Additional costs related to acquiring the contract include the costs of the marketing group which supports the sale manager. The total annual salaries for the marketing group are $400,000. On average, the marketing group works on 20 proposals each year.
This contract is expected to be profitable within the company’s normal profit margins.
ATT has a great credit rating and always pays its bills.
INSTRUCTIONS for PART 1: (70 points) Prepare an Accounting Issues Memo to the client, dated June 25, 2021 and addressing the following concerns of Video Solutions, Inc. Your memo should assume that the contract will be executed as described by July 1 and cash payment received within 3 days.
- VS is concerned if this contract will satisfy all of the conditions of the first criteria of revenue recognition related to a contract.
- The client is uncertain if there is one or more “performance obligations” which could affect the timing of revenue recognition.
- The company is uncertain about when and how to record the sale’s manager bonus and the other related marketing costs.
- The client wants guidance as to the implications for its income statement and balance sheet upon the receipt of the signed contract from ATT, on or near July 1, and receipt of payment of $9.5M on or near July 4. Specifically, the client wants to understand the impact on revenue and expenses and assets and liabilities. The client wants to see recommended journal entries upon receipt of the contract and the payment of $9.5 M.
- For this part, you do not need to allocate the price to different performance obligations, if there is more than one. That issue will be addressed in part 2.
Part 2
On July 1, 2021, Video Solutions, Inc received a signed contract for $10.1 million (before the $100,000 credit for the old equipment) with all negotiated terms, as described in part 1. Taking the “discount”, ATT wired $9.5 million to VS two days after the contract was signed. In the interest of full and expanded disclosure, VS has decided not to apply the practical expedient in ASC 606-10-32-18.
On May 31, 2022, the system became fully operational. The system was tested and accepted by ATT. The old surveillance equipment was decommissioned when the new system was installed. The old equipment was shipped to VS by June 1. VS sold the old surveillance equipment during June for $132,000.
For the sake of simplicity, no financing component needs to be allocated to the maintenance part of the contract.
VS management has forecasted a cost of $8,051,000 for the equipment and integration required by the contract. It has forecasted the cost of the maintenance services at $249,000 over the five years.
INSTRUCTIONS for PART 2: (50 points) Prepare a second modified Accounting Issues Memo addressing the concerns of Video Solutions with respect to the last 2 steps of revenue recognition. By modified, I mean you can eliminate the inclusion of the Codification excerpts. Codification citations are required, as well as all other sections of the Accounting Issues memo.
- The client is uncertain about the allocation of the transaction price, if more than 1 performance obligation was identified in part 1.
- The client is uncertain when revenue may be recognized during the time of the contract.
- The client wants guidance as to the implications for its financial statements as of the May 31 and June 30, 2022. (Note: Even if you conclude that some journal entries should be recorded monthly, for purposes of this case, show the cumulative journal entries recorded for the months of May and June. Show all calculations.)
Writing will count. Your responses must be supported by properly referenced Codification excerpts.
