A group of five successful business people were awarded the franchise for one of two new expansion teams in the North American Sports League (NASL). The professional sports franchise was named the Rockets Franchise (RF). The Rockets are scheduled to begin playing in the 2013/14 season. It is now June 2013, three months away from opening night. The group formed a joint venture to operate RF. The main reason for doing so was to gain the flexibility that they believed this structure could offer them.
RF has appointed your accounting firm as auditors for the year ending December 31, 2013. RF has also requested your firm's assistance with the development of RF's accounting policies. You, CA, assigned to the job, and the partner have met with the client. The following are notes from that meeting.
1. The venturers have various business backgrounds, and not all of them are looking for substantial financial reward.
However, there are limits to how much they are willing to invest if the project is not financially successful. Most have successful businesses already established and are looking for ways to get public exposure. Three of the venturers have each contributed $2 million in cash, which will be used for start-up costs. One of the venturers has contributed a parcel of land on which the new stadium will soon be built. The fifth venturer has contributed a combination of cash, office equipment, time, and industry knowledge.
2. A management group has been hired to operate RF on a day-to-day basis. However, any major decisions must have the approval of the five venturers.
3. Before the expansion team franchise was awarded, a proposal to the league's board of governors was prepared. As part of the proposal, RF had to commit to paying a $50-million franchise fee and had to meet other conditions. All these other conditions have been met. To strengthen its bid, RF took out local newspaper advertisements requesting signatures from the public and organized a local parade to demonstrate the enthusiasm of the city's sports fans.
The venturers spent a total of $3 million of their personal funds in their bid to obtain the franchise in addition to the funds invested in RF for start-up costs.
4. A new stadium is planned, to be ready by the beginning of the fourth season. In the meantime, RF has signed a five-year lease for the existing 10,500-seat stadium. As part of the lease, RF will be responsible for ensuring that the existing stadium meets local fire and safety regulations. It is estimated that $500,000 will have to be spent to meet these standards.
5. The Rockets' logo and color scheme have been scientifically developed by psychologists employed by a product design firm owned by one of the venturers. The cost was $1 million.
6. The $50-million franchise fee has been partially financed through several sources. Advance season ticket and advertising sales have accounted for $10 million; the NASL has provided an interest-free loan of $15 million, payable at the end of the third season; and the city provided a $5-million grant with no conditions.
RF has until the end of this calendar year to arrange the financing of the remaining funds or it will lose the franchise.
7. Revenues will be generated from several sources, as follows:
a. Ticket sales. Ticket sales will be in the form of pre-sold season tickets and game-day tickets. Thus far, 8,000 season tickets have been sold for the first season. Fans can also purchase the right to use private boxes throughout the stadium, at a premium. Five of the exclusive private boxes are reserved for the venturers, and 1,000 seats are restricted for promotional purposes and for players' families and friends at no charge. Ticket sales are handled by a local ticket agency for a fee of 5% of sales.
b. Advertising space. As part of a promotion to increase sales of advertising space in the stadium, RF has offered a discount of 15%, for the first year, to advertisers who purchase advertising space for two seasons. The advertisers are billed on an annual basis. There are 100 advertising spaces in the stadium, of which 25% have been purchased at the discounted price and 25% at the regular price. The regular price for an advertising space is about $80,000 per season. Any unsold space will be occupied by advertisements from the venturers' other businesses at no charge.
c. Merchandising sales. RF has sold the exclusive right to sell products using the Rockets' logo and design to a large sports clothing manufacturer for $5 million plus a royalty of 5% of gross sales for five years. If at the end of the five years the manufacturer has not sold $50 million worth of merchandise, RF will have to refund half of the 5% royalty payments made during the contract period. The $5 million is due immediately; the 5% royalty will be paid quarterly, commencing with the last quarter of this year.
d. Concession booth sales. During games, fans will be able to purchase hot dogs and popcorn at various concession stands. RF will operate the booths and pay the stadium a royalty of 10% of sales.
8. The major expense besides rent will be the players' salaries. RF has been able to acquire the rights to 15 veteran players from other established teams at no cost, except that RF must now honor the individual players' contracts. There are no real superstars in this group of players. Their average salary is about $200,000 per year, and the average remaining life of the contracts is 2½ years. Contracts are guaranteed whether or not the players play.
9. In June of every year the NASL holds its annual entry draft where the rights to young sports players from minor league teams, with no previous NASL experience, are acquired by NASL teams. Since the Rockets is an expansion team, they were awarded the first pick in this year's draft, enabling them to select one of the most promising players in the minor league. The Rockets have drafted 12 players in all, only three or four of whom are likely to see action in the fall of 2013 when the season begins. The remaining players will be sent to the minor league team for further development. The minor league team is owned by a local business that covers all costs except the players' salaries. As RF owns the players' contracts, it is responsible for their salaries.
Historically, 35% of all players selected play more than one season in the major league. The Rockets are confident that they have selected five players this year who are likely to see action in the next couple of years. They group the players in three categories (A, B, and C), which are also used to determine the players' compensation for their first contracts. Each player selected has signed a contract, as outlined in Exhibit C6-4(a).
10. To ensure that the Rockets become successful, RF has acquired Kelly McDowell from another team. Kelly was named last year's most valuable player in the league. In exchange, RF gave up two veteran players, as well as one Group B player from the entry draft, and its first-round draft pick for the next five years. Since Kelly is considered the best player in the league, RF also paid $5 million as part of the trade. Kelly's former team owners were offered
$15 million in cash by another team, but they felt that RF's offer was slightly better, and could be extremely beneficial if one of the future prospects ends up being a superstar.
Kelly's contract has five years remaining, at a guaranteed U.S. $1.2 million per year plus a bonus for 2013-14 of up to U.S. $500,000 if he repeats last year's performance. RF is trying to renegotiate Kelly's contract, which has a clause allowing him to negotiate a new deal with any other team in the league at the end of the 2013-14 season. RF has the right to match any offer but, if it does not, it will lose Kelly's rights and receive no compensation in return.
11. RF has also been able to sign a deal with a very talented Swiss player. The player was still under contract with the Swiss National Team at the time of signing. Claims for damages under similar circumstances in the past have been made against other teams by the Swiss National Team.
Historically, these claims have averaged about $100,000, but in recent cases the claims have reached $250,000. No claim has yet been made by the Swiss.
12. RF does not expect to be able to generate revenue from television or radio contracts for several years.
The partner has asked you to prepare a memo identifying the relevant accounting issues that are likely to arise during the audit of RF and discussing how they should be resolved.
Required
Prepare the memo to the partner.
EXHIBIT C6-4(a)
CONTRACT SUMMARY
1. Three Group A players have been signed by RF. These players are likely to play in the Rockets' major league team in the 2013 14 season. It is anticipated that RF's first selection overall in the draft will be the top rookie of the year and the scoring leader among the first-year players. The contracts of the Group A players contain the following terms:
$100,000/year guaranteed for three years
$50,000 signing bonus
$50,000 performance bonus based on points
$100,000 for Rookie-of-the-Year award
$25,000 if they play 50 or more games the first year
Free apartment, to be shared with another player
Free use of a company car for the first year
2. Four Group B players have been signed by RF. These players will generally play in the minor league for the first year and then will probably join the Rockets' major league team in the following season. However, there may be one player who proves talented enough to play in the major league this year.
Their contracts provide:
$50,000/year guaranteed for three years
$25,000 signing bonus
$2,000 per game if they get called up to play for the Rockets.
3. Five Group C players have been signed by RF. These players will play in the minor league and usually have only a remote chance of ever making it to the major league. It is likely that they will not be re-signed when the contract has expired. Their contracts provide:
$25,000/year guaranteed for three years
$10,000 signing bonus
$2,000 per game if they get called up to play for the Rockets
If they play more than 15 minor league games in a season, they get a new contract at the Group B level.