TLM, Inc., a struggling software development company, has been experiencing cash flow problems. To address working capital deficiencies, TLM entered into an agreement with one of its customers, Sunrise, Inc., and issued a two-year non-interest-bearing note with a face value of $5,000,000 and received $4,853,310 in exchange. This equates to an effective (implicit) interest rate of 1.5%. TLMs normal borrowing rate is 10%.

As the accountant for TLM, you question how the company obtained such a low interest rate and learn that the CEO made an oral side-agreement with Sunrise to provide free software support (e.g., installation, troubleshooting) over the next 5 years. You, therefore, conclude that the note and the future interest charges should be recorded at the market interest rate of 10%, resulting in larger yearly interest charges. Further, the value of the software support should be recorded as unearned revenue and recognized over the next 5 years.

Upper management disagrees with your conclusion and tells you that the interest expense required under assessment would turn the companys small positive net income into a net loss, as well as cause TLM to be in violation of existing debt covenants. Furthermore, the CEO states that the verbal agreement is nonbinding and to record revenue in such a situation would be earnings management. The CEO instructs you to record the transaction as if the side-agreement did not exist.

What are your responsibilities as an accountant in this situation? What are the issues involved in this dilemma? What will you decide to do? Why?