Reference no: EM131638307

Problem - Frantek, Inc. is a manufacturer of microcomputer parts and components. At the beginning of its fiscal year, Frantek entered into an agreement with Conte Technologies to manufacture microcomputer accessory boards according to Conte's specifications. The agreement provided that within the next 12 months Frantek was to deliver a minimum of 100,000 boards to Conte at a stipulated price per board. If Frantek failed to perform per the terms of the agreement, financial penalties were provided. In addition, the agreement required that Conte make royalty payments to Frantek on the basis of a predetermined schedule of units shipped. The royalty payments actually constitute a deferral of the selling price. The agreement stipulated that in no case would the royalty payments be less than $2 million. To assist Frantek with its working capital needs during the development stage of the boards, Conte loaned Frantek $6 million, payable in 36 months with accrued interest. 

Frantek encountered some technical difficulties in developing the boards according to Conte's satisfaction and was not able to meet the agreed-on timetable for the shipment of boards. The problem was that boards equipped with a certain manufacturer's chip did not meet Conte's operating standards. Frantek was able to solve the problem by having a third-party contractor replace the chip with a different manufacturer's chip that met Conte's standards. The contractor charged Frantek $7 per board to replace the chip.

As of Frantek's current year-end, Frantek had shipped only 38,000 boards and had 41,000 boards, with the unsatisfactory chip, in its year-end inventory. No royalty payments had been paid by Conte to Frantek. Conte recognized that Frantek had made a good faith effort to perform under the terms of the agreement and agreed to amend the agreement, effective as of Frantek's current year-end, as follows:

1. Conte would waive its rights to impose any financial penalties under the agreement.

2. Frantek would cease manufacturing the accessory boards per the agreement and not fulfill the 100,000 minimum.

3. Conte would purchase the 41,000 accessory boards in Frantek's inventory at 110 percent of Frantek's cost.

4. Any Conte purchases of boards would be paid for by reducing the $6 million loan from Conte to Frantek.

5. Conte has the right to order Frantek to replace the unsatisfactory chip in the remaining 41,000 boards. The cost of replacement is to be paid by Frantek. Any boards not ordered for chip replacement will be shipped to Conte at some specified future date.

6. Conte will pay Frantek the minimum royalty amount of $2 million specified in the original agreement. Conte will not be liable for any additional royalties.  Concurrent with the signing of the amended agreement, Conte ordered 20,000 of the remaining accessory boards held in Frantek's inventory to have the chip replaced.

Required:

For Frantek's current year-end as well as subsequent year-ends, discuss the accounting issues raised by the amendment to the agreement between Frantek and Conte.

Include in the discussion:

1) Analyze the relationship between measurement and recognition

2) Explain recognition criteria in the context of this case.

3)  A recommendation as to how Frantek should resolve issues relating to revenue recognition, inventory valuation, and liability recognition and classification.