Candy Apple Technologies

Candy Apple Technologies $($CAT$)$ is rela$$vely new company that designs video games and applica$$ons for mobile devices.

Users are able to download a game or applica$$on onto a mobile device for a fee that normally ranges from $99$ cents to

$$4\mathrm{.}99.$ In addi$$on$,$ users can play the company$$s games over the Internet.

The company was established by Thomas Waboose and Petra Bior, one year a$$er they completed a degree in computer

sciences. Thomas and Petra are excellent programmers and have been playing video games since they were children.

A$$er designing a mobile device game for an undergraduate course assignment, the two friends decided to start up CAT.

The company$$s games have been well received by the market and have been downloaded by over $5$ mil$-$ lion users across

the globe. In addi$$on$,$ the company$$s applica$$ons are also considered to be high quality.

The company experienced significant growth in its first five years of opera$$ons and decided to go public. Two analysts

are currently following CAT$$s shares, which are trading at $$13,$ and are preparing their first recommenda$$on$.$ CAT is

scheduled to release its financial results in two weeks during a conference call. Based on the results released by industry

compe$$tors$,$ analysts are expec$$ng the company to report revenue of $$7$ million and earnings of $$1\mathrm{.}5$ mil$-$ lion in the

current year.

You are the senior manager with Singh and Islam, LLP$,$ the auditors of CAT. Recently, you met with Thomas and Petra to

discuss the following transac$$ons that took place during the year:

$$ CAT entered into an agreement with Eastern Sports Corp. $($ESC$).$ The terms of the agreement required CAT to

provide in$-$game adver$$sing to ESC in exchange for ESC providing CAT with in$-$game adver$$sing on its website. CAT

normally does not sell adver$$sing space in its games, and likely would not have been able to sell the adver$$sing for cash.

Since this is a new transac$$on for CAT, the fair value is difficult to es$$mate$,$ but management believes the adver$$sing is

worth $$200,000.$ ESC normally sells in$-$game adver$$sing and es$$mates the fair value of the adver$$sing provided is

$$250,000.$ It is unlikely that CAT management would have paid cash for the adver$$sing received. The transac$$on has

been recorded as a credit to revenue and a debit to adver$$sing expense for $$200,000.$

$$ The company recently began selling the games of smaller companies on its website. The games are sold for $$1$

$($credit card payments only$),$ with $95$ cents going to the game designing company and $5$ cents being retained by CAT. The

selling price of the game is established by the game designer. The game designer retains any con$$nuing commitment to

the customer a$$er the game is purchased $($e$.$g$.,$ game updates, modifica$$ons$).$ During the year, $1$ million games were

downloaded, resul$$ng in CAT recording $$1$ million in revenue and $$950,000$ in cost of goods sold.

$$ CAT began selling two$-$year, nonrefundable memberships. The memberships are sold for $$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 $1\mathrm{.}5$ 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 of $$1,125,000$ during the current year as CAT has no further work required to

service the memberships. Currently, CAT has over $200$ 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. CAT

paid $$175,000$ for this exclusive right and incurred an addi$$onal $$475,000$ in programming costs to create the game, and

$$205,000$ in promo$$onal costs. CAT capitalized $$855,000$ as an intangible asset. The following are the expected

downloads for the game, which will be sold for $$1\mathrm{.}99$:

Downloads Probability Year $1$ Year $2$ Year $3$

Op$$mis$$c $25\%300,000200,00055,000$

Average $60\%165,00090,00020,000$

Pessimis$$c $15\%75,00050,0005,000$

$$ CAT purchased $30-$year bonds of another public company for $$500,000.$ The bonds were purchased in the prior

year and classified as FV$-$NI as the fair value was increasing as rates decreased. During the current year, the bonds

declined in value by $$40,000$ as central banks began to raise rates in order to combat infla$$on$.$ At the beginning of the

year, management reclassified the bonds to amor$$zed cost as the company plans on holding the bonds un$$l maturity,

and the bond is a pure debt instrument.

$$ At the beginning of the year, CAT issued $100,000$ redeemable preferred shares to the public for $$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, CAT was named in a patent in