Description
Option #2: Codification to Research a Complex Accounting Issue: Accounting for Software Development Activities
Read the Accounting for Software Development Activities Case Study (link below). After reading the case study, answer the questions provided.
While Ms. Larson is confident with the U.S. GAAP reporting of the CRM system developed in 2018 and used by MRM, she is less certain of the accounting for the software product developed for customers in 2019 due to the unique nature of the transaction as it relates to the company’s business. You have been asked to research the relevant guidance to determine the proper course of action for the 2019 financial statements. Specifically, Ms. Larson is interested in how the fees paid to ZD for the activities from March 1 to August 31 should be accounted for and how these costs, along with the fees generated from the three customers, should be presented on the 2019 financial statements.
As part of this task, perform the following activities:
First, consult the Financial Accounting Standards Board Accounting Standards Codification® to find appropriate guidance on the issues presented in the case.
Next, prepare the following three responses in paper format:
Prepare a detailed memorandum and analysis to Ms. Larson that includes the relevant issues for this situation, the appropriate financial reporting guidance, and your conclusion regarding the treatment of the fees generated and costs incurred for the software sold in 2019.
Prepare a detailed memorandum and analysis of Ms. Larson’s accounting for the CRM system in 2018. Specifically, determine whether her decisions regarding the (1) capitalization versus expensing of costs and (2) amortization of the CRM system are supported by U.S. GAAP. Address the specific evidence from the case, the relevant guidance from the Financial Accounting Standards Board Accounting Standards Codification®, and make adjustments, if any, to the 2018 financial statement.
After reviewing the following additional details, prepare a 3-page double-spaced memorandum and analysis summarizing the issues identified, and then providing guidance and a conclusion with appropriate treatment of each issue.
Additional details:
MRM management felt that its first three software clients could play a crucial role in MRM’s future strategy to create market awareness for its software product. Through discussions with the three companies, MRM management learned that each company was scheduled to participate in industry conventions in the first quarter of 2020.
According to the clients, these conferences typically provide companies and their employees the opportunity to interact with industry association members and competitors and discuss industry-specific developments.
Companies normally receive booth space in the main convention area, and some of the industry participants give presentations in adjacent conference rooms on topics of interest.
MRM management believed that these conferences would be a strategic venue to market their software products. However, admission to the conferences was exclusive to industry participants who paid significant association dues, and thus MRM had no way of attending the conferences independently, nor did they have established business connections with other companies within these industries.
Because of the significant opportunity, though, MRM management asked the three initial clients if they would promote the product at their respective conventions. Specifically, MRM wanted the companies to offer a demonstration of the software to other conference attendees and devote booth space to marketing pamphlets for the software.
Each company agreed to MRM’s request, but demanded a substantial fee given the significance of the promotional efforts and the uniqueness of such activity at the conferences. As such, MRM’s sales contracts for each of the three customers included an agreement for the customers to provide the software demonstrations and display pamphlets in exchange for a fee of $15,000 (for a total of $45,000), payable on December 19, 2019.
Considering the evidence from the case, including the additional information provided, identify the revenue recognition issues that potentially impact the accounting for the sales contracts in 2019. In the process, research the appropriate guidance from the Financial Accounting Standards Board Accounting Standards Codification® to determine how these issues should be addressed.
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Development of the System
Middle Road Media: A
Codification Research Case
on the Accounting for
Software Development
Activities
ABSTRACT:
The
accounting
for software
development costs is a complex issue within the
financial accounting curriculum. While intermediatelevel texts address the relevant issues, this case
provides a rich context for students to learn and
apply knowledge of the topic while developing
critical-thinking and professional research skills. The
instructional case addresses a hypothetical scenario
of a company’s development of an internal-use
software system that ultimately prompts the creation
of a software product sold by the company to
customers. Students are required to determine the
appropriate recognition of the software development
costs, as well as the presentation of those costs and
proceeds from customers on the company’s
financial statements.
Keywords: FASB Codification;
software development.
financial
reporting;
THE CASE
iddle Road Media, Inc. (hereafter, MRM) produces
a monthly political magazine, which it sells on a
12-month subscription basis. To meet the daily
demands of political readers, MRM also produces a
daily blog that includes contributions from many
authors who provide commentary on current
political issues. During the last quarter of
FY2017, company management solidified plans to expand its
services
to
‘‘premium’’
online
content—additional
commentaries, interviews with key political figures, short
documentaries, etc.—which will provide an additional revenue
stream. As part of this strategy, management decided it was
necessary to revamp some of its key systems to provide the
company with the appropriate information to enable it to
deliver services in an optimal way.
To partially address this initiative, MRM management
needed a new customer relationship management (CRM)
database, as the company previously managed customer
account information (other than billing information, which is
included in the accounting system) through an archaic off-theshelf database system. This database demanded extensive
maintenance efforts on the part of MRM’s customer service
and billing staff to coordinate information between systems
and update key customer information. For many years, it
served the company’s needs, but with the growth of the
subscription base and competitive forces, a new system was
warranted.
M
In a planning meeting, key employees from different
company departments (hereafter, the team) determined that
the new system must be integrated with the company’s
accounting system while maintaining its independent
functionality. To reduce staff time spent updating customer
information in the system, the team wanted to integrate the
new software with the existing customer portal such that
customers could update profile data, etc. Since this type of
design would require a sophistication unique to MRM, the
team decided it would be appropriate to build an inhouse system. Given the limited information technology
(IT) capabilities at the company, the team chose to retain the
services of Dynamic Consulting, a firm specializing in the
development of fully functional systems integration. Per the
agreement, Dynamic firm professionals conducted the
entire project without requiring any labor resources from
MRM. However, the professionals instructed the company
to purchase a new computer server specifically dedicated
to the new system.
136
TABLE 1
Timeline of Events for CRM Development
February 22, 2018
May 9, 2018
July 23, 2018
November 11, 2018
November 25, 2018
Dynamic begins designing the CRM application
Dynamic completes the formal design process and begins SQL coding
Dynamic finishes the substantial portion of coding and begins testing the application
Dynamic completes testing and installs application on the company’s server
The company begins using the application
On February 22, 2018, Dynamic began creating the system, and the project was completed and placed into service on
November 25 of the same year. The timeline of events is displayed in Table 1.
While Dynamic professionals completed the application on November 11, they spent the next two weeks, i.e., until
November 25, training company employees on matters regarding the use of the system. Part of the training process involved
educating the IT personnel of the company on maintenance issues. After November 25, Dynamic’s involvement in the project
was complete.
In determining the financial reporting of the new system, the company Controller, Sara Larson, produced conclusions for
the 2018 costs, which are presented in Table 2.
Ms. Larson, through discussions with the Dynamic consultants and MRM IT personnel, also determined that the system
would be useful for approximately five years. As such, the intangible asset was amortized on a straight-line basis for one month
on the 2018 financial statements. The 2018 balance sheet contained the necessary line items, presented in Table 3, for the
intangible assets section.
Subsequent Activity
After one month of use, the team, still intact from the beginning of the project, felt it necessary to perform an independent
systems audit as part of the review procedures and ongoing significant maintenance for the new system. Because Dynamic was
not independent with respect to the system, the team solicited the services of ZD Consulting to perform the engagement. The
audit process commenced on January 27, 2019 and took two weeks to complete (one week after the 2018 financial statements
were issued). While the audit did not turn up any significant issues, the ZD auditing team presented an interesting
recommendation: MRM should sell the software to companies with similar needs in non-competing industries.
The ZD auditors discussed with MRM management the problems faced by clients in other industries with respect to their
CRM systems. The auditors were confident that MRM’s system offered a workable solution for some of these clients. The
auditors believed that three to five clients would be interested in the software application, but some changes would be required
to render the software user-friendly and in saleable condition. Besides performing systems audits, ZD also specialized in
assisting companies in developing software applications to be sold, as well as providing software support. As such, ZD offered
to prepare a proposal for the company, at no charge, detailing how the process would work.
ZD was very interested in this project because it offered great fee potential for the firm. First, this situation provided ZD the
opportunity to generate significant fees in transforming the company’s CRM system into a marketable product. Second, since
MRM lacked the foundation for offering customer support for the marketed product, ZD could also earn business from MRM’s
potential software customers, who would likely demand support services. MRM management was also interested in how the
sale of the software could introduce another primary revenue stream to its income statement. As such, the company agreed to
listen to ZD’s proposal.
TABLE 2
Financial Reporting Actions for CRM System Development
Cost Activity
Costs incurred prior to February 22, 2018 for system planning
Dynamic fees for activities from February 22, 2018–November 11, 2018
Costs incurred from November 11, 2018–November 25, 2018 for training
Costs incurred after November 25, 2018 for maintenance
Financial
Reporting Decision
Associated
Cost
Included in Operating Expenses
Capitalized as an intangible asset
Included in Operating Expenses
Included in Operating Expenses
$110,000
$6,390,000
$185,000
$329,000
Middle Road Media: A Codification Research Case on the Accounting for Software Development Activities
137
TABLE 3
2018 Balance Sheet Line Items for CRM System
Account Name
Amount
CRM System
Accumulated Amortization: CRM System
$6,390,000
(106,500)
The proposal was comprehensive, and included a detailed market analysis for similar products and the steps required to
prepare the product for the market. Per the proposal, ZD lined up three commitments (along with non-disclosure agreements)
from its clients that were interested in purchasing a version of MRM’s software. Additionally, two other clients expressed
interest, but needed more time to determine whether the software was suitable for their needs. Overall, the analysis indicated a
high demand for such a product in a few key industries. For the software to be marketed, ZD suggested that the current CRM
application would require a re-designed graphical user interface, significant new coding (approximately 50 percent of the
coding in MRM’s in-house system would need to be replaced) in an updated programming language, and intensive beta testing.
After agreeing to ZD’s proposal, the creation of the software product was initiated on March 1. While ZD professionals
were responsible for building the software product, the contract clearly stipulated that MRM controlled the development of the
product, thereby assuming all risks during and after the development process. Additionally, MRM was to control the software
after completion of the project and was responsible for fulfilling the contracts with all customers (including the three
commitments from ZD clients). Table 4 provides a timeline of the development process and the cumulative cost incurred in
2019 for the project.
While the finished product contained features and functionality not present on the CRM system developed in 2018 and
used by MRM, the work performed by ZD did allow MRM to improve the functionality of its in-house system. The contract
between MRM and the three customers stipulated that the software version completed on August 31 would be installed on the
customers’ servers by MRM employees on September 15. The agreed-upon price was $500,000 per customer, payable in two
installments ($250,000 on September 15 and $250,000 on December 19). Because this was the first product offered by the
company, the sales price did not include any software upgrades or customer support. However, ZD offered each customer a
separate customer support contract with no involvement by MRM. By the end of 2019, MRM had focused significant resources
on marketing the product to potential customers.
Main Case Requirements
While Ms. Larson is confident with regard to the U.S. GAAP reporting of the CRM system developed in 2018 and used by
MRM, she is less certain as to the accounting for the software product developed for customers in 2019 due to the unique nature
of the transaction as it relates to the company’s business. You have been asked to research the relevant guidance to determine
the proper course of action for the 2019 financial statements. Specifically, Ms. Larson is interested in how the fees paid to ZD
for the activities from March 1–August 31 should be accounted for and how these costs, along with the fees generated from the
three customers, should be presented on the 2019 financial statements. As part of this task, you should perform the following
activities:
(1) Consult the Financial Accounting Standards Board Accounting Standards Codification to find appropriate guidance
on the issues presented in the case.
TABLE 4
Timeline for Development of 2019 Software
Date
Milestone
Cumulative
2019 Cost
March 1, 2019
May 13, 2019
July 23, 2019
ZD initiates design of new graphical user interface
ZD completes graphical user interface design and commences additional coding
ZD completes working model for the software that is ready for beta testing with
three confirmed customers
$0
$1,135,000
$3,083,000
August 31, 2019
Beta testing is completed by ZD
$3,758,000
September 15, 2019
Three customers purchase software
$3,758,000
138
(2) Prepare a detailed, 1.5–2-page memo to Ms. Larson that includes the relevant issues for this situation, the appropriate
financial reporting guidance, and your conclusion regarding the treatment of the fees generated and costs incurred for
the software sold in 2019.
Optional Requirements
Optional Requirement 1
Analyze Ms. Larson’s accounting for the CRM System in 2018. Specifically, determine whether her decisions regarding
the (1) capitalization versus expensing of costs and (2) amortization of the CRM system are supported by U.S. GAAP. In a
written response, please address the specific evidence from the case, relevant guidance from the Financial Accounting
Standards Board Accounting Standards Codification, and adjustments, if any, that should be made to the 2018 financial
statements.
Optional Requirement 2
In addition to the text from the case, consider the following additional details:
MRM management felt that its first three software clients could play a crucial role in MRM’s future strategy to create
market awareness for its software product. Through discussions with the three companies, MRM management learned that each
company was scheduled to participate in industry conventions in the first quarter of 2020. According to the clients, these
conferences typically provide companies and their employees the opportunity to interact with industry association members and
competitors and discuss industry-specific developments. Companies normally receive booth space in the main convention area,
and some of the industry participants give presentations in adjacent conference rooms on topics of interest. MRM management
believed that these conferences would be a strategic venue to market their software products. However, admission to the
conferences was exclusive to industry participants who paid significant association dues, and thus MRM had no way of
attending the conferences independently, nor did they have established business connections with other companies within these
industries. Because of the significant opportunity, though, MRM management asked the three initial clients if they would
promote the product at their respective conventions. Specifically, MRM wanted the companies to offer a demonstration of the
software to other conference attendees and devote booth space to marketing pamphlets for the software. Each company agreed
to MRM’s request, but demanded a substantial fee given the significance of the promotional efforts and the uniqueness of such
activity at the conferences. As such, MRM’s sales contracts for each of the three customers included an agreement for the
customers to provide the software demonstrations and display pamphlets in exchange for a fee of $15,000 (for a total of
$45,000), payable on December 19, 2019.
Optional requirement. Considering the evidence from the case, including the additional information provided, identify
the revenue recognition issues that potentially impact the accounting for the sales contracts in 2019. In the process, research the
appropriate guidance from the Financial Accounting Standards Board Accounting Standards Codification to determine how
these issues should be addressed. In a written response, provide a summary of the issues identified, the relevant guidance, and a
conclusion as to the appropriate treatment of each issue.
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Explanation & Answer:
9 Pages
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Financial Accounting Standards
Accounting for Software Development
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