Rosetta Inc. Rosetta Inc. (RT) is a new corporation that just acquired the assets of an unincorporated technology business on Sep- tember 1, 2019, from Jess Stone. Extracts from the purchase and sale agreement entered into by RI and Jess Stone are provided in Exhibit I. RI is owned by three shareholders: Carlos Guevara, the CEO of RI, who owns 20% of the shares of RI; and two investors, who each own 40% of the shares. Jess Stone is not a shareholder of RI. Jess Stone developed new touch screen technology but lacked the financial resources necessary to benefit com- mercially from this technology. The touch screen technology is far superior to the current technology and has many potential uses, ranging from mobile devices, computer screens, and laptops. RI put the technology it purchased to work immediately by entering into a licensing agreement with Mica Inc. (Exhibit II). In addition, RI has developed a new PC computer monitor with the touch screen and entered into an agree- ment with Ferrous Inc. to distribute the technology You, CPA, have been recently employed by RI as the special assistant to Carlos Guevara. On July 3, 2020, Carlos calls you into his office and says he has an assignment for you: "The financial statements of RI for the fiscal year ending August 31, 2020, are required to be audited. I want you to address the significant financial accounting issues pertaining to the preparation of RI's financial statements for its first fiscal year ending August 31, 2020, and provide your recommendations on the accounting treatments to be used." As you leave Carlos's office, he provides you with a file that includes some additional information about the opera- tions of RI (Exhibit III). Required Prepare a report that addresses the requests of Carlos Guevara. Exhibit 1 Extracts from the Purchase and Sale Agreement Between RI and Jess Stone Purchase and Sale of the Business Assets of Jess Stone Contingent Consideration RI will purchase the technology and the research findings of Jess RI agrees to pay to Jess Stone an amount equal to 50% of net Stone as at September 1, 2019 income (determined in accordance with generally accepted RI agrees to purchase the equipment owned by Jess Stone as at accounting principles) in excess of $500,000 for the fiscal year September 1, 2019 ending August 31, 2020 Jess Stone agrees to be responsible for all liabilities as at Employment Contract with Jess Stone September 1, 2019 RI and Jess Stone agree to enter into a two-year employment Purchase and Sale Price contract, and RI agrees to pay to Jess Stone an annual salary RI will pay to Jess Stone an amount of $3.5 million for the of $200,000 technology and the research findings Jess Stone agrees that all research findings during the employ- RI agrees to pay to Jess Stone the appraised value of $420,000 ment are the property of RI for the equipment Exhibit II Extracts from the Licensing Agreement Between RI and MICA Inc. Licensing Arrangement Royalty RI agrees to provide to Mica the exclusive right to use the touch Mica agrees to pay to RI a royalty fee in the amount of 15% of screen technology referred to as FeldsparX for a term of three the gross margin (determined in accordance with generally years commencing on December 1, 2019 accepted accounting principles) realized by Mica from sales of RI agrees to deliver the technology to Mica on December 1, 2019 goods that use the FeldsparX technology Mica agrees to pay to RI a licensing fee in the amount of Mica agrees to provide to RI a quarterly statement of gross margin $900,000, with the first payment of $300,000 due on December 1, realized by Mica that is subject to the royalty payable to RI 2019; and agrees to make payments in the amount of $300,000 RI, or its representative, has the right of access to the records plus interest of $36,000 on December 1, 2020, and $300,000 and information of Mica necessary to audit the gross margin plus interest of $18,000 on December 1, 2021 reported by Mica to RI Exhibit II Information Obtained About the Operations of RI Licensing Arrangement with Mica Jess Stone has started work on a new project, Kryptonite, after Revenue in the amount of $300,000 has been recognized in the becoming an employee of RI and this project is presently in the accounting records conceptual formulation state of a possible product that uses the Royalty revenue in the amount of $135,000 has been recognized technology. in the accounting records based on a gross margin of $900,000 A research and development asset in the amount of $3.5 million reported by Mica for the six months from December 1, 2019,10 is reported on Ri's statement of financial position as at May 31, May 31, 2020 2020. All research and development costs incurred by RI have been Mica is a financially sound entity expensed in the accounting records. Research and Development Sales Arrangement with Ferrous Inc. RI acquired the following technology and research findings from Ferrous Inc. has placed a large order for PC touch screen monitors Jess Stone: produced by RI that uses the Quartz technology. The sales agree- ment requires RI to have the goods available for delivery to Ferrous Project Technology/ by August 31, 2020 and to make deliveries to Ferrous as requested Assigned Name Fair Value Current Status during September and October 2020. Ferrous will be holding a spe- cial sales event during these months. Ferrous has requested that the Feldsparx $ 700,000 licensed to Mica for three goods are not to be delivered until September and October as they years (see Note 1) do not have the warehouse space to store all of the items for the spe- Quartz 1,500,000 used in the commercial cial sale. Revenue pertaining to this agreement is $2,500,000 and production of goods the related direct production costs are estimated to total $1,350,000. (see Note 2) These goods will be covered by RI's inventory insurance. Basalt 900,000 used in the commercial Ferrous made the nonrefundable fee payment of $1,250,000 production of goods required by this agreement on June 1, 2020. This amount has been (see Note 3) recognized as sales revenue. The final $1,250,000 is to be paid by Grandiorite 400,000 testing use in a possible Ferrous on October 31, 2020. Ferrous is a financially sound entity. product Sales Arrangement with Mega Mart Ltd. $3,500,000 RI entered into an agreement with Mega Mart Lid., a large global retailer, to distribute a lower-end touch screen for price-sensitive customers. This touch screen makes use of the Basalt technology. Note 1-FeldsparX Technology: Management of RI decided to the sales agreement requires RI to deliver units of the touch screen license use of the FeldsparX technology rather than to produce to Mega Mart. Mega Mart will display the screens in a prime loca- goods using this technology itself. Management expects that this tion and retain 20% of the per-unit sales price ($50 per unit), with technology will have a useful life of three years. the remaining 80% of the sales price to be sent to RI. Any unsold Note 2 Quartz Technology: Management of RI estimates that touch screens that are not sold by Mega Mart will be returned to the Quartz technology will generate total revenue in the amount RI. In addition, Mega Mart will provide RI an upfront payment of of $7.5 million over a four-year period commencing Decem- $250,000 in order to help offset working capital requirements. ber 1, 2019. According to the sales agreement, RI shipped 30,000 units to Note 3-Basalt Technology: Management estimates that the Mega Mart Lid. in April 2020. At the time of delivery, RI recorded Basalt technology will generate total revenue in the amount of revenue of $1.2 million, debited cash for $250,000, and set up an $2.7 million over a three-year period commencing March 1, 2020. accounts receivable for the remaining $950,000. Rosetta Inc. Rosetta Inc. (RT) is a new corporation that just acquired the assets of an unincorporated technology business on Sep- tember 1, 2019, from Jess Stone. Extracts from the purchase and sale agreement entered into by RI and Jess Stone are provided in Exhibit I. RI is owned by three shareholders: Carlos Guevara, the CEO of RI, who owns 20% of the shares of RI; and two investors, who each own 40% of the shares. Jess Stone is not a shareholder of RI. Jess Stone developed new touch screen technology but lacked the financial resources necessary to benefit com- mercially from this technology. The touch screen technology is far superior to the current technology and has many potential uses, ranging from mobile devices, computer screens, and laptops. RI put the technology it purchased to work immediately by entering into a licensing agreement with Mica Inc. (Exhibit II). In addition, RI has developed a new PC computer monitor with the touch screen and entered into an agree- ment with Ferrous Inc. to distribute the technology You, CPA, have been recently employed by RI as the special assistant to Carlos Guevara. On July 3, 2020, Carlos calls you into his office and says he has an assignment for you: "The financial statements of RI for the fiscal year ending August 31, 2020, are required to be audited. I want you to address the significant financial accounting issues pertaining to the preparation of RI's financial statements for its first fiscal year ending August 31, 2020, and provide your recommendations on the accounting treatments to be used." As you leave Carlos's office, he provides you with a file that includes some additional information about the opera- tions of RI (Exhibit III). Required Prepare a report that addresses the requests of Carlos Guevara. Exhibit 1 Extracts from the Purchase and Sale Agreement Between RI and Jess Stone Purchase and Sale of the Business Assets of Jess Stone Contingent Consideration RI will purchase the technology and the research findings of Jess RI agrees to pay to Jess Stone an amount equal to 50% of net Stone as at September 1, 2019 income (determined in accordance with generally accepted RI agrees to purchase the equipment owned by Jess Stone as at accounting principles) in excess of $500,000 for the fiscal year September 1, 2019 ending August 31, 2020 Jess Stone agrees to be responsible for all liabilities as at Employment Contract with Jess Stone September 1, 2019 RI and Jess Stone agree to enter into a two-year employment Purchase and Sale Price contract, and RI agrees to pay to Jess Stone an annual salary RI will pay to Jess Stone an amount of $3.5 million for the of $200,000 technology and the research findings Jess Stone agrees that all research findings during the employ- RI agrees to pay to Jess Stone the appraised value of $420,000 ment are the property of RI for the equipment Exhibit II Extracts from the Licensing Agreement Between RI and MICA Inc. Licensing Arrangement Royalty RI agrees to provide to Mica the exclusive right to use the touch Mica agrees to pay to RI a royalty fee in the amount of 15% of screen technology referred to as FeldsparX for a term of three the gross margin (determined in accordance with generally years commencing on December 1, 2019 accepted accounting principles) realized by Mica from sales of RI agrees to deliver the technology to Mica on December 1, 2019 goods that use the FeldsparX technology Mica agrees to pay to RI a licensing fee in the amount of Mica agrees to provide to RI a quarterly statement of gross margin $900,000, with the first payment of $300,000 due on December 1, realized by Mica that is subject to the royalty payable to RI 2019; and agrees to make payments in the amount of $300,000 RI, or its representative, has the right of access to the records plus interest of $36,000 on December 1, 2020, and $300,000 and information of Mica necessary to audit the gross margin plus interest of $18,000 on December 1, 2021 reported by Mica to RI Exhibit II Information Obtained About the Operations of RI Licensing Arrangement with Mica Jess Stone has started work on a new project, Kryptonite, after Revenue in the amount of $300,000 has been recognized in the becoming an employee of RI and this project is presently in the accounting records conceptual formulation state of a possible product that uses the Royalty revenue in the amount of $135,000 has been recognized technology. in the accounting records based on a gross margin of $900,000 A research and development asset in the amount of $3.5 million reported by Mica for the six months from December 1, 2019,10 is reported on Ri's statement of financial position as at May 31, May 31, 2020 2020. All research and development costs incurred by RI have been Mica is a financially sound entity expensed in the accounting records. Research and Development Sales Arrangement with Ferrous Inc. RI acquired the following technology and research findings from Ferrous Inc. has placed a large order for PC touch screen monitors Jess Stone: produced by RI that uses the Quartz technology. The sales agree- ment requires RI to have the goods available for delivery to Ferrous Project Technology/ by August 31, 2020 and to make deliveries to Ferrous as requested Assigned Name Fair Value Current Status during September and October 2020. Ferrous will be holding a spe- cial sales event during these months. Ferrous has requested that the Feldsparx $ 700,000 licensed to Mica for three goods are not to be delivered until September and October as they years (see Note 1) do not have the warehouse space to store all of the items for the spe- Quartz 1,500,000 used in the commercial cial sale. Revenue pertaining to this agreement is $2,500,000 and production of goods the related direct production costs are estimated to total $1,350,000. (see Note 2) These goods will be covered by RI's inventory insurance. Basalt 900,000 used in the commercial Ferrous made the nonrefundable fee payment of $1,250,000 production of goods required by this agreement on June 1, 2020. This amount has been (see Note 3) recognized as sales revenue. The final $1,250,000 is to be paid by Grandiorite 400,000 testing use in a possible Ferrous on October 31, 2020. Ferrous is a financially sound entity. product Sales Arrangement with Mega Mart Ltd. $3,500,000 RI entered into an agreement with Mega Mart Lid., a large global retailer, to distribute a lower-end touch screen for price-sensitive customers. This touch screen makes use of the Basalt technology. Note 1-FeldsparX Technology: Management of RI decided to the sales agreement requires RI to deliver units of the touch screen license use of the FeldsparX technology rather than to produce to Mega Mart. Mega Mart will display the screens in a prime loca- goods using this technology itself. Management expects that this tion and retain 20% of the per-unit sales price ($50 per unit), with technology will have a useful life of three years. the remaining 80% of the sales price to be sent to RI. Any unsold Note 2 Quartz Technology: Management of RI estimates that touch screens that are not sold by Mega Mart will be returned to the Quartz technology will generate total revenue in the amount RI. In addition, Mega Mart will provide RI an upfront payment of of $7.5 million over a four-year period commencing Decem- $250,000 in order to help offset working capital requirements. ber 1, 2019. According to the sales agreement, RI shipped 30,000 units to Note 3-Basalt Technology: Management estimates that the Mega Mart Lid. in April 2020. At the time of delivery, RI recorded Basalt technology will generate total revenue in the amount of revenue of $1.2 million, debited cash for $250,000, and set up an $2.7 million over a three-year period commencing March 1, 2020. accounts receivable for the remaining $950,000