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.