Assignment #2: Professional Research Memo Hammers and Roses Construction (Hammers and Roses or HNR) is a construction company that builds commercial and residential buildings. On April 1, 2019, HNR will enter into a contract with a customer, Borough Apartments, to construct a residential apartment building for a cash price of $15 million. HNR estimates that it will incur costs of $10 million to complete construction of the apartment building. The apartment building will only transfer to Borough Apartments once the construction of the entire building is complete. Borough Apartments has various design requirements that would require HNR to incur significant costs to rework the building before selling it to a customer other than Borough Apartments. If Borough Apartments cancels the contract, HNR will be entitled to reimbursement for costs incurred for work completed to date plus a margin of 20 percent, which is considered to be a reasonable margin. Hammers and Roses will not be reimbursed for any materials that have been purchased for use in the contract but have not yet been used and are still controlled by HNR. To construct the apartment building, HNR acquires standard materials that it regularly uses in its other construction projects for both residential and commercial buildings. These materials are used to manufacture generic component parts for inclusion in Borough Apartments residential buildings. These standard materials remain interchangeable with other items and can be used by HNR for other projects until they are deployed in the Borough Apartments building. The cost of the installed components is included in the $10 million construction cost estimate. The contract calls for four payments of $3,750,000. The $3.75 million payments are due on the date the contract is signed (April 1, 2019), July 1, 2019, October 1, 2019, and when the building is complete and transferred to Borough Apartments. In addition to the $15 million in cash, there is a $1 million per month bonus if construction is completed before February 2020 and a $1 million penalty per month if the construction is completed after February 29, 2020. Any completion bonus would increase, and any penalty reduces the balance due upon completion. Hammers and Roses has a large number of contracts with completion bonuses or penalty clauses similar to the contract with Borough. The schedule below shows the potential completion bonus or penalty and HNRs assessment of the likelihood of each scenario occurring. While no specific outcome is probable, HNR managements assessment of the likelihood of completing the construction in the specified time frame is based on significant historical experience with similar building projects. Project Completed: Likelihood Bonus Penalty Prior to December 2019 0% $3,000,000+ During December, 2019 10% $2,000,000 During January 2020 25% $1,000,000 During February 2020 40% $0 During March 2020 15% ($1,000,000) During April, 2020 10% ($2,000,000) May, 2020 or later 0% ($3,000,000+) Professional Research Memo Assignment #2 Fall 2018 ACC 303 Page 2 of 2 Borough Apartments has an excellent credit rating and is known to pay invoices when due. HNR's Sales Manager and HNR's sales department were delighted that the contract was signed as the contract triggers two sales incentive bonus programs. The Sales Manager earned a commission equal to two percent (2%) of the fixed price under the contract. The Sales Manager's commission is paid when Borough signs the contract and the first payment is made. Also, one percent (1%) of the cash price for all contracts signed is credited to a sales department bonus pool. All sales department employees share in the pool based on an agreed-upon formula. The bonus pool payment is additional incentive compensation for members of the sales department beyond their normal salary. The bonus pool is paid out to the members of the sales department at July 1 for contracts signed in the first six months of the year, and December 31st for all contracts signed in the second half of the year. The total annual fixed cost of the sales department including salaries and excluding any incentive bonuses is $700,000. During a typical year, the sales department will work on 30 to 40 proposals. Required: Prepare a professional accounting research memorandum in proper form with reference to the appropriate sections of the FASB codification. In preparing the memo, review ASC 606 Revenue from Contracts with Customers for the five steps in the revenue recognition model and ASC Subtopic 340-40 Other Assets and Deferred Cost Contracts with Customers. For each of the five steps ASC 606: o Analyze how each revenue model step applies to the transaction between HNR and Borough Apartments. Refer to the proper ASC Topic section in your memo. For any step that is not applicable, indicate it is "not applicable." o Draw a conclusion as to the implications of that step to HNR. Show any computations used in describing your conclusion. o In determining the Transaction Price (Measurement) pay special attention to ASC 606-10-32-2 through 606-10-32-14. o In determining Satisfaction of Performance Obligation (Recognition) discussed in ASC 606-10-25-23 to ASC 606-10-25-25, consider: o The criteria for satisfying a performance obligation over time as described in ASC 606-10-25-27 thru ASC 606-10-25-29 versus performance obligations satisfied at a point in time in ASC 606-10-25-30, and o How Progress toward satisfaction of a performance obligation is determined. See ASC 606-10-25-33 to ASC 606-10-25-37. Review ASC Subtopic 340-40 and analyze the treatment of payments made to HNRs sales manager and sales department. In your memo,