General background:

EYE SPY sells sophisticated video surveillance equipment. EYE SPY sells the equipment and computer integration services together. It does not sell these separately. The equipment cannot operate without being fully integrated with a computer system. Significant customization is required during this integration. Other competitors could theoretically provide computer integration services. Historically, EYE SPY has not sold maintenance services.

The sales manager for EYE SPY has just obtained a signed contract from Secret Manufacturing (SM) to provide and perform computer integration services for surveillance equipment at a cost of $10 million, and have everything operational within one year, at which time full payment is due. SM will not get control of the video surveillance equipment until the integration is completed and EYE SPY turns control of the system over to SM. Management expects to be able to have the system fully operational and available for use by SM in the 12th month of the contract.

EYE SPY believes this system would also be valuable to SMs competitors. The contract price of $10 million includes a five-year maintenance agreement that will commence after the installation is completed. SM has a great credit rating and always pays its bills. EYE SPYs sales manager is very pleased because he will receive a 2% bonus based on the gross sales contract price, and it is payable upon receipt of a signed contract.

EYE SPY maintains a marketing group to work on contract proposals. The total annual salaries for the marketing group are $400,000. On average, the marketing group works on 20 proposals each year. This contract is expected to have a 15% to 20% margin.

At the end of 11 months, the system is fully operational. The system has been tested and accepted by SM. The old surveillance equipment was decommissioned when the new system was installed. The old equipment was shipped to EYE SPY in month 11. The old surveillance equipment was sold the next month for $120,000. For the sake of simplicity, no financing component needs to be allocated to the maintenance contract.

Requirement:

4.1 Perform step five of the revenue recognition model and recognize revenue as performance obligations are satisfied. By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.

4.2 Record any required journal entries for revenue, deferred costs, etc., through the 11th and 12th months of the contract (Note: While some journal entries may have been recorded monthly, for purposes of this case, show the cumulative journal entry recorded through the 11th and 12th months).