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 acreditof $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 management's assessment of the likelihood of completing the integration in the specified time frame is based on significant historical experience with similar integration jobs.