Thomas Technologies Corporation (TTC) is an engineering services company based in Calgary. He company’s Class B common shares are listed on the Toronto Stock Exchange. He Class A common shares are all owned by Theodore thomas, the company founder, and his immediate family. The Class A shares are multiple voting shares that assure that the thomas family retains voting control over the company. The company’s shares have risen sharply in price over the past two years, driven mainly by the strength of the Alberta economy and the need for engineering services by the many resource and exploration companies based in Calgary. Stock analysts have been very enthusiastic about TTC shares and analysts have issued very favorable earnings forecasts for TTC’s 20X4 year- end results. In 20X4, TTC entered into special long- term contracts with two of its largest clients. The company’s accounting staff recorded the transactions as directed by the TTC chief Financial officer. The two transactions were as follows:
1. TTC entered into a three-year contract with Howard Limited to provide engineering services. The services would be rendered on an as-needed basis over the three years. The contract stated that Howard would pay $3 million to TTC at the start of the contract and the remaining amount would be paid over the next two years: $2 million one year later in 20X5, and $1.6 million in 20X6. Howard made the first payment as required in 20X4. TTC recorded the payment as revenue for 20X4. The cost of services rendered by TTC to Howard is not separately tracked but is part of the regular service provided by TTC to many clients.
2. TTC and Parker Inc. signed an agreement on 14 October 20X4. As one part of the agreement, TTC designed and built a special purpose piece of equipment for Parker. Parker did not solicit bids from other manufacturers due to the close working relationship that has been established between Parker and TTC over the years. It is possible, however, that similar equipment could have been obtained for about 20% less from a heavy equipment manufacturer in Japan. The agreement provided that Parker would pay $5.6 million for the equipment. The equipment was delivered to Parker on 22 December 20X4. Parker paid 40% of the purchase price on 30 December, with a promise to pay the remaining 60% within the first 90 days of 20X5. The equipment cost TTC $3.4 million to construct. The agreement provided that Parker could not sell or otherwise convey the equipment to any other user. In addition to the equipment sale, the agreement stipulated that Parker would pay $1.5 million per year for the next four years as a service contract. The price is about 25% less than ITC would normally charge a client for that type of service. TTC recorded revenue of $5.6 million for the equipment, and included $3.4 million _in cost of services. The company also recorded the first years' service revenue by credit-Trig $1.5 million to revenue and debiting accounts receivable—long term. This revenue was matched by charging $1.0 million to cost of services (for the estimated cost of pro-viding the service) and crediting an equal amount to estimated service liability.
It now is January 20X5. You are working for the audit firm of Andrew,Athens, and Argoyle on the annual audit of TTC. The audit manager is preparing to meet with the TTC CFO tomorrow morning. She has asked you to prepare a memorandum in which you set out your views on the accounting used by TTC accounting, and any alternatives that you propose.
Prepare the memorandum for your audit manager.