Mobile Gaming Inc. (MGI) is relatively new company that designs video games

and applications for mobile devices. Users are able to download a game or

application onto a mobile device for a fee that normally ranges from 99 cents to

$4.99. In addition, users can play the company's games over the internet at the

company's website.

The company was established by Harold James and Olivia Zee, one year after

they completed a degree in computer sciences. Harold and Olivia are excellent

programmers and have been playing video games since they were children. After

designing a mobile device game for an undergraduate course assignment, the

two friends decided to start up MGI. The company's games have been well

received by the market and have been downloaded by over 5 million users

across the globe. In addition, the company's applications are also considered to

be high quality.

The company experienced significant growth in its first five years of operations

and are wondering if they should go public in the next few years. Harold and

Olivia are excited about the prospect about going public however the Board of

Directors wants to see the latest financial results before deciding on the next

course of action for the company. Based on the results released by industry

competitors, the Board of Directors are expecting the company to report revenue

of $7 million and earnings of $2 million in the current year.

You are the senior manager with White and Hellen, LLP, the auditors of MGI.

Recently, you met with Harold and Olivia to discuss the following transactions

that took place during the year:

MGI began selling 2-year, non-refundable memberships. The memberships

are sold for $75 and allow users to download any 100 games during the twoyear

period. During the year, 15,000 memberships were sold. Accordingly,

members can download up to a maximum of 1.5 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 $1,125,000 during the

current year as MGI has no further work required to service the

memberships. Currently, MGI has over 100 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. MGI paid $175,000 for this exclusive right and

incurred an additional $475,000 in programming costs to create the game,

and $205,000 in promotional costs. MGI capitalized $855,000 as an intangible asset. The following are the expected downloads for the game, which will be sold for $1.99.

Probability Year 1 Year 2 Year 3

Optimistic 25 300000 200000 55000

Average 60 165000 90000 20000

Pessimistic 15 75000 50000 5000

Lease payments for the new company car have been capitalized. Monthly

payments are $400 for the three-year lease. 10 monthly payments have

been made so far. If MGI had purchased the car, it would have cost

$30,000. The car has an expected useful life of six years. Depreciation has

not yet been recorded. Current interest rate is 6%.

At the beginning of the year, MGI 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, MGI was named in a patent infringement lawsuit in regard

to the use of various trademarked logos. The Company's lawyers believe

that there is a 50% chance that the case will be settled with no damages to

be paid by MGI. However, there is a chance that the company may have to

pay between $100,000 and $200,000 in damages. As of year end, both the

$100,000 and $200,000 amounts are equally likely (50% each).

Draft ASPE financial statements reveal revenue and earnings of $7,478,000

and $2,257,000, respectively. Management displayed their excitement for

their ability to meet the Board's revenue and earnings expectations. The

partner has asked you to prepare a memo for the audit file that discusses the

appropriate accounting treatment for only 3 (three) of the above-noted

transactions. While the memo will be used as part of the audit planning

process, you are not expected to comment on audit related issues.

Required:

Prepare the memo.