Reference no: EM132973619

Sports Inc. (SI) is a company whose primary activities are hosting a real-time, online fantasy football website and writing and publishing an annual magazine that discusses fantasy football strategies, predictions, and articles. SI has an August 31 year end. This year end was selected as the main football season begins in September.

SI is a privately held company, owned by John and David, two friends who started the business to build on their affinity of fantasy football and capture a portion of the $800-million industry. John holds a computer science degree, and David holds an Honours Bachelor of Commerce degree and is a professional accountant. By providing faster service, along with more statistics, projections, and game play options, John and David felt that they could offer a unique service that differentiates their website from all of the competitors. In addition, SI is seeking to expand its services by offering fantasy coverage of American college and Canadian professional football, to go along with American professional footbalL

Given the significant growth in the industry, SI has recently received many offers to sell the business. John and David are unsure about selling their business as they enjoy their jobs and believe that there will be room for future business growth. However, the owners also know that fantasy football could be just another fad that is currently at its peak. In addition, the rate of change in the on-line gaming industry could lead to a possible alternative platform. Therefore, the owners feel it is prudent to at least consider the offers to sell.

A general review of the purchase offers suggests that fantasy football companies generally sell for an average of 2 times revenues and 5 times net earnings. The owners review the internal financial statements for 2019, which report revenues of $955,000 and earnings of $516,250. John quickly determines that SI could be sold for $2,047,500 or just over $1 million for each owner. This is a considerable sum of money given that they have invested only five years with SI. However, David states that the internal financial statements are only draft at this stage because he has yet to consider the impact of the following events:

1. SI writes an annual fantasy football magazine. The magazine goes on sale in July and is sold through the company's website and through various retailers. This year, SI secured a large contract with Books, a large book and magazine retailer in Canada. The contract allows Books to return any unsold magazines at the end of October (history suggest that annual magazines no longer sell after October as they become outdated and lose their relevance). A total of 40,000 magazines were shipped to Books in July. Books will be required to pay SI $3 per magazine if all 40,000 are sold, $3.50 per magazine if less than 40,000 but more than 20,000 magazines are sold, and $4 per magazine if less than 20,000 are sold. The magazines have a retail price of $6.99. The cost to develop the content and publish the magazine was incurred in the months of April to July. Accordingly, David recorded $120,000 in revenue when the magazines were shipped. Historically, SI has sold 70% of its stock prior to August. John and David believe that the amount of foot traffic at Books should increase the percentage of magazines sold.

2. SI revised the layout, graphics, and content of the annual magazine this year. The redesign resulted in an addition $50,000 in expenses in the current year, relative to the past three years, whereby the magazine maintained the same format as in prior years. Magazines normally go through a redesign phase every three to four years in order to provide readers with a fresh and current magazine. David has capitalized the $50,000 as an intangible asset (magazine design). The finite life asset will be amortized over its useful life.

3. SI earns the majority of its revenue from fees charged to use its website to host a fantasy football league. SI charges users $20 per season (seasons run from September to January). This year SI offered two new promotions: a) Early Bird Registration: Users who register and pay for a season prior to August 31 would be eligible for a reduced $15 fee. The fee is non-refundable and must be used for the upcoming fantasy football season. A total of 5,000 users took advantage of the early bird price for the upcoming season. Revenue was recorded as users registered. b) Three-Year Membership Fee Reduction: Users can register and pay for the next three seasons for a total price of $30. The fee is non-refundable and must be used for the upcoming three fantasy football seasons. A total of 7,000 users registered for the three-year membership fee. Revenue was recorded as users registered for the three-year seasons' package.

4. In addition to redesigning the annual magazine, SI also redesigned its website. The redesign resulted in some general changes, along with significant upgrades to the functionality of the website. The total cost of the website redesign was $95,000, including $30,000 for advertising. David has capitalized all $95,000 in costs to the website intangible asset.

5. On June 1, SI was sued by a competitor for a patent infringement suit. Legal counsel suggests that SI will be liable to make a payment. There is a 30% chance of a $50,000 payment, a 50% chance of a $100,000 payment, and a 20% chance of a $150,000 payment. David recorded a $150,000 contingent liability. Given the nature of the company's operations, the vast majority of all costs are fixed overhead costs related to staff support, server maintenance, hardware maintenance, and website design. Any variable costs are immaterial.

Required: It is now September 2, 2019. Assume the role of David's assistant accountant.

a) Briefly discusses the company background and user needs/objectives

b) Lists all of the accounting issues briefly. No explanation of each issue is needed in this section.

c) Analyzes four accounting issues in depth by applying GAAP to the accounting issue and providing recommendations.

d) Calculate and comment on the purchase price estimate for the company based on your analysis.