Games-a-lot! (GAL) is relatively new company that designs video games and applications for mobile devices. Users are
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Question:
The company was established by Harold James and Olivia Zee, one year after they completed a degree in computer sciences. Harold and Olivia are excellent programmers and have been playing video games since they were children. After designing a mobile device game for an undergraduate course assignment, the two friends decided to start up GAL. The company's games have been well received by the market and have been downloaded by over 5 million users across the globe. In addition, the company's applications are also considered to be high quality.
The company experienced significant growth in its first five years of operations and are wondering if they should go public in the next few years. Harold and Olivia are excited about the prospect about going public however the Board of Directors wants to see the latest financial results before deciding on the next course of action for the company. Based on the results released by industry competitors, the Board of Directors are expecting the company to report revenue of $7 million and earnings of $2 million in the current year.
You are the senior manager with White and Hellen, LLP, the auditors of GAL. Recently, you met with Harold and Olivia to discuss the following transactions that took place during the year:
• GAL began selling 2-year, non-refundable memberships. The memberships are sold for $75 and allow users to download any 100 games during the two year period. During the year, 15,000 memberships were sold. Accordingly, members can download up to a maximum of 1.5 million games under the membership. On average, a member downloads 85 games. During the current year, a total of 475,000 games were downloaded under the agreement. Management decided to record revenue $1,125,000 during the current year as GAL has no further work required to service the memberships. Currently, GAL has over 100 games in its library available for download.
• During the year, the company purchased the rights to develop a game based on a popular comic book hero. GAL paid $175,000 for this exclusive right and incurred an additional $475,000 in programming costs to create the game, and $205,000 in promotional costs. GAL capitalized $855,000 as an intangible asset. The following are the expected downloads for the game, which will be sold for $1.99.
• Lease payments for the new company car have been capitalized. Monthly payments are $400 for the three-year lease. 10 monthly payments have been made so far. If GAL had purchased the car, it would have cost $30,000. The car has an expected useful life of six years. Depreciation has not yet been recorded. Current interest rate is 6%.
• At the beginning of the year, GAL issued 100,000, redeemable preferred shares to the public for $5 each. The preferred shares have a dividend yield of 7%. The preferred shares must be redeemed if the common share price exceeds $20 per share. Dividends of $35,000 were declared and paid during the year.
• During the year, GAL was named in a patent infringement lawsuit in regard to the use of various trademarked logos. The Company's lawyers believe that there is a 50% chance that the case will be settled with no damages to be paid by GAL. However, there is a chance that the company may have to pay between $100,000 and $200,000 in damages. As of year end, both the $100,000 and $200,000 amounts are equally likely (50% each).
Draft ASPE financial statements reveal revenue and earnings of $7,478,000 and $2,257,000, respectively. Management displayed their excitement for their ability to meet the Board's revenue and earnings expectations. The partner has asked you to prepare a memo for the audit file that discusses the appropriate accounting treatment for only 3 (three) of the above-noted transactions. While the memo will be used as part of the audit planning process, you are not expected to comment on audit related issues.
Required: Prepare the memo.
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