MSY Incorporated (or "MSY") is a worldwide provider of business intelligence software that enables companies to report, analyze and monitor the data stored across their enterprise to reveal the trends and insights needed to make better business decisions. MSY's single, integrated platform is designed to support various styles of business intelligence through an easy-to-use interface. MSY's software is used by workgroups and the enterprise and extranet communities via E-mail, Web, wireless and voice communication channels. MSY also offers services to its customers and partners, including consulting, education, and technical support, accounting for 60 per cent of sales. Customers number over 1,700 and include retail, telecommunications, pharmaceutical insurance, manufacturing, and financial services companies. In business intelligence software, MSY competes with Microsoft, Oracle, Hyperion Solutions, SAPAG. Computer Associates, and SAS. The company markets its products and services through partners and a direct sales force. MSY has over 480 technology and integration partners, including IBM, PeopleSoft, and JD Edwards. The company has attributed recently improved operating performance to the launch of MSY 8, its software platform that enables users to query and analyze the most detailed, transaction-level databases, and turn data into business intelligence as well as delivering boardroom quality reports and alerts about the users' business processes. However, despite these positive business trends, some sceptical commentators have expressed concerns about the company's accounting policies. For example, The Center for Financial Research and Analysis in the United States raised questions about certain accounting practices at MSY in a report issued in November 2005. Some of these concerns related to the three accounting areas outlined in 1. to 3. Below: 1. Revenue recognition 'Deferred revenue and advance payments' in the balance sheet relates to product support and other services resulting from payments received prior to the performance of services for consulting, education and technical support. Since 1 January 2004, however, certain work billed to customers for services to be provided has been recorded as revenue as it is invoiced to them (this invoicing is normally undertaken at the beginning of the service period in advance of the work being completed, which takes, on average three years). This revenue is included under product support and other services in the income statement (see Exhibit 1). This accounted for $25 million of reported revenue in the year ended 31 December 2005. $25 million was also recorded as revenue on this basis in the year ended 31 December 2004. Software Development Costs Accounting Policy 2. Details Software development costs are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to customers. Capitalized software development costs include direct and indirect labor costs, interest on loans used to pay software engineers salaries, depreciation on buildings in which software development takes place, fringe benefit costs attributed to programmers, software engineers and quality control and field certifiers working on products after they reach technological feasibility but before they are generally available to customers for sale. Technological feasibility is considered to be achieved when a product design and working model of the software product are deemed 60 per cent complete. Capitalized software development costs are amortized over the estimated product life of 10 years, on a straight-line basis. The Company conducts an analysis of the net realizable value of capitalized software development costs once every three years and currently considers that there is no indication of impairment of the capitalized software development costs as future sales seem adequate to support amortization costs. 3. 'Channel Stuffing In early 2006, MSY announced that it sent as much as $14 million worth of education support software products into wholesalers' warehouses in late 2005 despite no orders having been received. This was recorded as revenue in 2005. The company's cost of sales percentage on these products was 30 per cent. The company's marginal tax rate for 2005 was 30 per cent. Years Raded December 31, Wil 2014 2005 2003 IHNE NIRMINIMI RAISIRMININ $ 99,926 S 96.995 S 77221 168,736 134,213 98,356 268,662 231.208 175.577 INFAHMI EM AM FREIHIN MERA 3,886 32.565 36,451 212.211 3.875 28.996 32,871 198,337 3.240 24.745 27.985 147.592 PRIR HERMERE HER HINNER H. MMMM 704420 31.471 6,82 69,924 24.015 34.077 57475 27.684 32580 1.699 TRZ ML1920 27.972 38.344 93.867 71 129.887 68.450 M 2,974 (94) (127) 1.221 (53) (83) 14 KS. 109 Revenue Product licenses Product support and other services Total revenues Cost of revenues Product licenses........ Product support and other services ...... Total cost of revenues ...................... Cross profit Operating expenses Sales and marketing Research and development General and administrative Restructuring and impairment charges Amortization of intangible asses Total operating expenses Income from operations Financing and other income (expense) Interest income . Interest expense, including discount amortization expense or $2.137 in 2003 LONS on investments Loss on early extinguishment of notes payable Other income (expense), net Total financing and other income (expenses Income (low from continuing operations before income laten Provision (benefit for income taxes..... Net income (lon) from continuing operations... Discontinued operations Gain from abandonment Income from discontinued operations Net income (ons) Basic earnings (los) per here: Continuing operations SARL Discontinued operation Net Income (los) attributable to common Mkholders Weighted average share outstanding used in computing basic earning Clos per shume Diluted earnings (loss) per share: Continuing operations Discontinued operation Net Incore (loss) attributable to common stockholder Weighted average share outstanding bed in computing diluted amingxKlon TEL 0.550 4.800 98,170 33,427 64,743 (215) 870 62.220 (98.993 TOR 319) 307 35227) (7255) (2.567 (4,668) MILE KHEMAH ANG 765 765 HER HEHEHEMIAH HINA MISHI $ 64.74 516, 20.3 2003) 10.05 SO 0.26) 14.768 16035 14804 DHANIE 4.1 S INS 9.3031) 0.08 9.83 (0.26) 4.19 15,436 17.119 14804 pere Requirement: Indicate what adjusting journal entries you would post to the accounts for 2004 and 2005 to reflect a more conservative accounting treatment of these 'revenues! Hint: Ensure you show the debit and credit journal entries with figures. Indicate any concerns you have with the accounting policy related to software development costs accounting of MSY. Question 8 10 pts Propose journal entries to restate the transactions described under 'channel stuffing' of MSY. MSY Incorporated (or "MSY") is a worldwide provider of business intelligence software that enables companies to report, analyze and monitor the data stored across their enterprise to reveal the trends and insights needed to make better business decisions. MSY's single, integrated platform is designed to support various styles of business intelligence through an easy-to-use interface. MSY's software is used by workgroups and the enterprise and extranet communities via E-mail, Web, wireless and voice communication channels. MSY also offers services to its customers and partners, including consulting, education, and technical support, accounting for 60 per cent of sales. Customers number over 1,700 and include retail, telecommunications, pharmaceutical insurance, manufacturing, and financial services companies. In business intelligence software, MSY competes with Microsoft, Oracle, Hyperion Solutions, SAPAG. Computer Associates, and SAS. The company markets its products and services through partners and a direct sales force. MSY has over 480 technology and integration partners, including IBM, PeopleSoft, and JD Edwards. The company has attributed recently improved operating performance to the launch of MSY 8, its software platform that enables users to query and analyze the most detailed, transaction-level databases, and turn data into business intelligence as well as delivering boardroom quality reports and alerts about the users' business processes. However, despite these positive business trends, some sceptical commentators have expressed concerns about the company's accounting policies. For example, The Center for Financial Research and Analysis in the United States raised questions about certain accounting practices at MSY in a report issued in November 2005. Some of these concerns related to the three accounting areas outlined in 1. to 3. Below: 1. Revenue recognition 'Deferred revenue and advance payments' in the balance sheet relates to product support and other services resulting from payments received prior to the performance of services for consulting, education and technical support. Since 1 January 2004, however, certain work billed to customers for services to be provided has been recorded as revenue as it is invoiced to them (this invoicing is normally undertaken at the beginning of the service period in advance of the work being completed, which takes, on average three years). This revenue is included under product support and other services in the income statement (see Exhibit 1). This accounted for $25 million of reported revenue in the year ended 31 December 2005. $25 million was also recorded as revenue on this basis in the year ended 31 December 2004. Software Development Costs Accounting Policy 2. Details Software development costs are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to customers. Capitalized software development costs include direct and indirect labor costs, interest on loans used to pay software engineers salaries, depreciation on buildings in which software development takes place, fringe benefit costs attributed to programmers, software engineers and quality control and field certifiers working on products after they reach technological feasibility but before they are generally available to customers for sale. Technological feasibility is considered to be achieved when a product design and working model of the software product are deemed 60 per cent complete. Capitalized software development costs are amortized over the estimated product life of 10 years, on a straight-line basis. The Company conducts an analysis of the net realizable value of capitalized software development costs once every three years and currently considers that there is no indication of impairment of the capitalized software development costs as future sales seem adequate to support amortization costs. 3. 'Channel Stuffing In early 2006, MSY announced that it sent as much as $14 million worth of education support software products into wholesalers' warehouses in late 2005 despite no orders having been received. This was recorded as revenue in 2005. The company's cost of sales percentage on these products was 30 per cent. The company's marginal tax rate for 2005 was 30 per cent. Years Raded December 31, Wil 2014 2005 2003 IHNE NIRMINIMI RAISIRMININ $ 99,926 S 96.995 S 77221 168,736 134,213 98,356 268,662 231.208 175.577 INFAHMI EM AM FREIHIN MERA 3,886 32.565 36,451 212.211 3.875 28.996 32,871 198,337 3.240 24.745 27.985 147.592 PRIR HERMERE HER HINNER H. MMMM 704420 31.471 6,82 69,924 24.015 34.077 57475 27.684 32580 1.699 TRZ ML1920 27.972 38.344 93.867 71 129.887 68.450 M 2,974 (94) (127) 1.221 (53) (83) 14 KS. 109 Revenue Product licenses Product support and other services Total revenues Cost of revenues Product licenses........ Product support and other services ...... Total cost of revenues ...................... Cross profit Operating expenses Sales and marketing Research and development General and administrative Restructuring and impairment charges Amortization of intangible asses Total operating expenses Income from operations Financing and other income (expense) Interest income . Interest expense, including discount amortization expense or $2.137 in 2003 LONS on investments Loss on early extinguishment of notes payable Other income (expense), net Total financing and other income (expenses Income (low from continuing operations before income laten Provision (benefit for income taxes..... Net income (lon) from continuing operations... Discontinued operations Gain from abandonment Income from discontinued operations Net income (ons) Basic earnings (los) per here: Continuing operations SARL Discontinued operation Net Income (los) attributable to common Mkholders Weighted average share outstanding used in computing basic earning Clos per shume Diluted earnings (loss) per share: Continuing operations Discontinued operation Net Incore (loss) attributable to common stockholder Weighted average share outstanding bed in computing diluted amingxKlon TEL 0.550 4.800 98,170 33,427 64,743 (215) 870 62.220 (98.993 TOR 319) 307 35227) (7255) (2.567 (4,668) MILE KHEMAH ANG 765 765 HER HEHEHEMIAH HINA MISHI $ 64.74 516, 20.3 2003) 10.05 SO 0.26) 14.768 16035 14804 DHANIE 4.1 S INS 9.3031) 0.08 9.83 (0.26) 4.19 15,436 17.119 14804 pere Requirement: Indicate what adjusting journal entries you would post to the accounts for 2004 and 2005 to reflect a more conservative accounting treatment of these 'revenues! Hint: Ensure you show the debit and credit journal entries with figures. Indicate any concerns you have with the accounting policy related to software development costs accounting of MSY. Question 8 10 pts Propose journal entries to restate the transactions described under 'channel stuffing' of MSY