Part I:

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 12^th 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.

Part II:

Part I should be completed before beginning Part II.

Background:

In the initial contract negotiation stage, the contract price with SM was $10.1 million in cash. However, as part of the final contract negotiations, SM agreed to give EYE SPY 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, EYE SPYs management believes it is probable that the estimated fair value of the old equipment is $115,000.

There was also a provision in the contract that SM would receive a discount (similar to that which, would be reflected in a separate financing transaction between EYE SPY and SM) from the contract price of $10 million if they paid within three days of when the contract was signed. EYE SPY 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 the contract. SM wired $9.5 million to EYE SPY two days after the contract was signed. In the interest of full and expanded disclosure, EYE SPY has decided not to apply the practical expedient in ASC 606-10-32-18.

Due to deep security concerns and recent losses of proprietary information, SM also offered a bonus to EYE SPY if the integration was completed early and EYE SPY agreed to pay a penalty if the integration was completed late. EYE SPY has a large number of contracts with bonus characteristics similar to the contract with SM. The following is the schedule of the potential bonus or penalty. While no specific outcome is probable, EYE SPYs management 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%

Requirements:

Review ASC 606-10-32-2 through 21.

Perform step three of the revenue recognition model and determine the transaction price. By reference to the applicable accounting literature, provide a detailed analysis to support your conclusion.

Record any required journal entries for the first two days of the contract beyond what was recorded in Part I. Prepare any required updated T accounts