Overview: On June 20, 2020, your public accounting firms account manager for Video Solutions, Inc. (VS), a new client, has asked you to prepare a memo addressing the clients concerns about the application of revenue recognition guidance (Topic 606). The management of Video Solutions has informed you that it is about to complete negotiations with All Things Tech, Inc. (ATT) to install a customized monitoring system for the customers manufacturing plant. This contract will have features that are not routinely included in the contracts with its other customers.

Your clients concerns about the application of topic 606 on revenue recognition guidance appear at the end of each part of the case.

The Case, Part 1:

VS sells sophisticated video surveillance equipment. VS sells the customized 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, but VS does not sell its equipment separately. ATT will not get control of the video surveillance equipment until the integration is completed and VS turns control of the fully operational system over to ATT.

The sales manager for VS anticipates receiving a signed contract from ATT to provide equipment and to perform computer integration services for that surveillance equipment by July 1. VS is committed to having everything operational for ATT within one year of the contract signing, at which time full payment is due from ATT.

In the initial contract negotiations, the contract price with ATT was $10.1 million in cash. However, as part of the final contract negotiations, ATT agreed to give VS its old surveillance equipment in exchange for a credit of $100,000. It is expected that this old surveillance equipment will not be decommissioned until the new equipment is operational. Based on its extensive experience, VS management believes it is probable that the estimated fair value of the old equipment at the contract inception date will be $115,000.

During the negotiations, VS offered maintenance services of the equipment, after the equipment is fully operational and turned over to ATT. Prior to this contract, VS has not provided maintenance services. Initially, VS proposed the 5 years of monthly maintenance services for $350,000 total included as part of the contract price. ATT informed VS that several competitors were offering attractive pricing to obtain this maintenance work. In order get the maintenance work, VS has agreed to offer the maintenance services for $290,000, as part of the contract price. This five-year monthly maintenance agreement will commence after the installation is completed.

There is also a provision in the contract that ATT would receive a discount from the contract price of $10.1 million if ATT pays the cash component within three days of when the contract is signed. This discount is similar to that which would be reflected in a separate financing transaction between VS and its other customers. VS determined a discount of $500,000 for this financing based on applying the typical credit rate for the equipment and integration services to be delivered at the end of year one and the monthly delivery of maintenance services in year two through six of this contract.

Due to deep security concerns and recent losses of proprietary information, ATT also is offering a bonus to VS if the integration is completed early and VS has agreed to pay a penalty if the integration is completed late. VS has a large number of contracts with bonus characteristics similar to this proposed contract with ATT. The following is the schedule of the potential bonus or penalty. While no specific outcome is probable, VS managements assessment of the likelihood of completing the integration in the specified time frame is based on significant historical experience with similar integration jobs.

Completed	Bonus	Penalty	Percentage
10 months	$100,000		17%
11 months	50,000		27%
12 months	0	$ 0	46%
13 months		(50,000)	7%
14 months		(100,000)	3%
15 months plus		(500,000)	0%
Total			100%

ATT has a great credit rating and always pays its bills.

INSTRUCTIONS for PART 1: Prepare an Accounting Issues Memo to the client, dated June 25, 2020 and addressing the following concerns of Video Solutions, Inc. Your memo should assume that the contract will be executed as described by July 1 and cash payment received within 3 days.

• VS is concerned if this contract will satisfy all of the conditions of the first criteria of revenue recognition related to a contract.
• The client is uncertain if there is one or more performance obligations which could affect the timing of revenue recognition.
• The client wants guidance as to the implications for its income statement and balance sheet upon the receipt of the signed contract from ATT, on or near July 1, and receipt of payment of $9.5M on or near July 4. Specifically, the client wants to understand the impact on revenue and expenses and assets and liabilities. The client wants to see recommended journal entries upon receipt of the contract and the payment of $9.5 M.
• For this part, you do not need to allocate the price to different performance obligations, if there is more than one.