After graduating with a degree in computer systems and design, Terry Park set up a company to design and produce computer games for arcades. Terry hired two other designers because of the anticipated volume of business. One designer, Kim, is paid an hourly wage. The second, Marie-Hélène, is paid 50% of the revenue received by Terry on the games designed or redesigned by Marie-Hélène. Terry rents an office where they all work and provides all the necessary equipment, supplies, and other items. Terry is not paid a wage but keeps all of the profits earned.
Terry realized there were two kinds of business: speculative design and custom design. For the speculative designs, Terry or one of the designers would think of a new game and then design, program, and test it. Terry would then try to sell it to a distribution company, for either a fixed price or a percentage (which ranges from 10% to 25%) of the total revenues earned by the game. To date, Terry has sold three of the four games produced. He is currently negotiating the sale of the fourth game.
For the custom design business, Terry would receive an order from a distribution company for either the design of a new game or the redesign of an existing game (which occurs frequently because games have a useful life of only six months as players quickly get bored with them). Terry negotiates either a fixed fee payable upon completion, or an hourly rate based on the estimated length of time it should take to redesign the game. Terry sets the hourly rate based on the perceived difficulty of the project, but the rate is always at least triple the amount paid to Kim. For the hourly rate contracts, Terry submits monthly invoices showing the number of hours worked on the project.
Required:
a. What revenue recognition options are open to Terry? Which one(s) would you recommend and why?
b. Using your recommended revenue recognition policy, how would you account for all of the costs incurred by Terry?