Accounting Issues Memos

100 Points

Overview: This project requires the preparation of a complete accounting issues memo for part 1, using the format in the Collins text. The second part requires a modified version of the memo. The project is a 2-part case about a clients concerns with respect to the application of Topic 606 revenue recognition guidance to one of its contracts. Codification citations are required and writing counts.

This end of the semester project is about the application of the guidance found in Topic 606. The first part of the project requires analysis of the first 3 steps of revenue recognition. Part 2 focuses on the last 2 steps of revenue recognition.

The first accounting issues memo is worth 60 points and is due Wednesday, November 29 at 11:55 p.m. The second memo (in a modified format, see below) is due no later than Friday, December 8 at 11:55 p.m. and is worth 40 points. These are the same dates as listed in the syllabus. There are no extensions for any reason.

Your memos should be addressed to the client, Contemporary Strategies, Inc. Rubrics are provided for each part.

Overview: On April 20, 2021, your public accounting firms account manager for Contemporary Strategies, Inc. (CS), a new client, has asked you to prepare a memo addressing the clients concerns about the application of revenue recognition guidance (Topic 606). The management of Contemporary Strategies has informed you that it is about to complete negotiations with Twin Tech, Inc. to install a customized monitoring system for the customers assembling plant. This contract will have features that are not routinely included in the contracts with its other customers.

Your clients 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:

CS sells sophisticated, customized video surveillance equipment, coupled with the installation of the equipment. The installation involves integrating its customized equipment with its customers computer systems. CS does not sell its equipment without an installation agreement, nor does CS offer installation services for other vendors surveillance equipment. The equipment cannot operate without being fully integrated with a computer system. Significant customization is required during this integration.

The CS sales manager has notified her management that she anticipates receiving a signed contract from Twin Tech to provide equipment and to perform computer integration services for that surveillance equipment by May 1, 2021. CS management has agreed to have everything operational for Twin Tech at the one-year anniversary of the contract signing. Twin Tech will not get control of the video surveillance equipment until the integration is completed when CS will turn control of the fully operational system over to Twin Tech. At that point, full payment of the contract price is required to be delivered to CS by Twin Tech.

The contract price with Twin Tech is $12.2 million in cash. Twin Tech has agreed to give CS its old surveillance equipment in exchange for a credit of $200,000. It is expected that this old surveillance equipment will not be decommissioned until the new equipment is operational. Based on its extensive experience, CS management believes it is probable that the estimated fair value of the old equipment at the contract inception date will be $240,000.

For the first time, CS offered maintenance services of the equipment, after the equipment is fully operational and turned over to Twin Tech. Prior to this contract, CS has not provided maintenance services. During negotiations, CS proposed the 5 years of monthly maintenance services for $450,000 total included as part of the $12.2 million contract price. Twin Tech informed CS that several competitors were offering more attractive pricing to obtain this maintenance work. In order get the maintenance work, CS agreed to provide the maintenance services for $400,000, as part of the contract price of $12.2 million. This five-year monthly maintenance agreement will commence after the installation is completed.

Due to deep security concerns and recent losses of proprietary information, Twin Tech also is offering a bonus to CS if the integration is completed early and CS has agreed to pay a penalty if the integration is completed late. CS has a large number of contracts with bonus characteristics similar to this proposed contract by Twin Tech. The following is the schedule of the potential bonus or penalty agreed to and included in the contract, as well as the probability of completing within time period, as estimated by CS. CS managements estimate of the probabilities related to completion were not shared with Twin Tech. While no specific outcome is probable, CS managements assessment of the likelihood of completing the integration in the specified time frame is based on significant historical experience with similar integration jobs.

Completed Within	Twin Techs Promised Bonus	Penalty	CS Probabilities
10 months	$200,000		17%
11 months	100,000		27%
12 months	0	$ 0	46%
13 months		(100,000)	7%
14 months		(200,000)	3%
15 months plus		(500,000)	0%
Total			100%

CS customarily offers other customers financing for similar projects. For customers who do not want the financing and are willing to pay upfront, CS offers a reduction in the contract price. In the Twin Tech contract, CS offers a discount of $500,000 from the contract price of $12.2 million if Twin Tech 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 Twin Tech accepted the financing by CS. CS determined a discount of $500,000 for this financing based on applying its typical credit rate for the equipment and integration services.

Twin Tech has a great credit rating and always pays its bills.

This contract is expected to be profitable.

INSTRUCTIONS for PART 1: (60 points) Prepare an Accounting Issues Memo to the client, dated April 25, 2021, addressing the following concerns of Contemporary Strategies, Inc. Based on discussions with the client, your memo should assume that the contract will be executed as described by May 1, that Twin Tech will forgo financing, and instead Twin Tech plans to make a cash payment of $11.5 million within 3 days of signing the contract. CS will begin work immediately upon receipt of a signed contract.

• CS wants confirmation that 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 client wants confirmation as to what will be the basis of the transaction price.
• CS 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 May 1, and receipt of payment of $11.5M on or near May 4. The client wants to see recommended journal entries upon receipt of the contract and the payment of $11.5 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 May 1, 2021, Contemporary Strategies, Inc received a signed contract for $12.2 million (before the $200,000 credit for the old equipment) with all negotiated terms, as described in part 1. Twin Tech wired $11.5 million to CS two days after the contract was signed. In the interest of full and expanded disclosure, CS has decided not to apply the practical expedient in ASC 606-10-32-18.

On March 31, 2022, the system became fully operational. The system was tested and accepted by Twin Tech. The old surveillance equipment was decommissioned when the new system was installed. The old equipment was shipped to CS by April 1. CS sold the old equipment during April for $250,000.

For the sake of simplicity, no financing component needs to be allocated to the maintenance part of the contract.

CS management has forecasted a cost of $8,721,000 for the equipment and integration required by the contract. It has forecasted the cost of the maintenance services at $550,800 over the five years.

INSTRUCTIONS for PART 2: (40 points) Prepare a modified Accounting Issues Memo, dated March 30, 2022, addressing the concerns of Contemporary Strategies with respect to the last 2 steps of revenue recognition. By modified, I mean you can eliminate the inclusion of the facts section and the Codification excerpts, but include the analysis section, conclusion, and journal entries. You must include Codification citations to support your analysis and journal entries.

• Identify and explain to the client the allocation of the transaction price, if more than 1 performance obligation was identified in part 1.
• Explain to the client 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 April 1 and May 1, 2022. Provide the appropriate journal entries. (Show all calculations.)