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Revenue and Liability Recognition, Inventory Valuation

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.


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Revenue Recognition, Inventory Valuation, and Liability Recognition

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 ...

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