Planning the Audit of the Term Paper

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(the Company) to the Loan Agreement with Western Financial Services (the Lender). For the purpose of providing you with this letter, other than as set out herein, we have carried out the audit and review of the Company's financial information

Report

Based solely on the procedures set out in the engagement letter dated October 9, 20X5 (see Attachment 1) we confirm that the Company is in compliance with all of its restrictive debt covenants with the Lender.

Our report as set out herein is confidential to the addressees of this letter and should not be made available to any other party without our written consent.

Yours faithfully

Charles Adam

Partner cc Chairman of the Board of Directors, Keystone Computers & Networks, Inc.

Memo

To FILES

From Warren Love

Karren West

Date November 14, 20X5

Subject Keystone Computers & Networks, Inc.

Revenue recognition - Accounting for the sale of extended warranty contracts

ISSUE:

When to recognize revenue from sale of extended warranty contracts?

At what amount should revenue from sale of extended warranty contracts be recognized?

RESOLUTION: FASB and IASB had a joint revenue recognition project wherein they developed a conceptual model for the 'asset and liability approach' to defining and recognizing revenues.

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This approach focuses on identifying and measuring increases in assets and decreases in liabilities both at fair value, arising from contracts. Key decisions used as basis for this approach are enumerated below:

Revenue recognition should be based on changes in assets and liabilities

Contractual obligations arise when the customer is committed to pay for the deliverables

These contractual obligations should be measured at fair value.

EXAMPLE:

If KCN sells a microcomputer for $300 and also charges $100 for its extended warranty contracts, and related warranty servicing cost is at $30, what amount should be recorded as revenue when the full amount of the purchase price and warranty fee is collected in full?

The asset and liability approach measures the assets and liabilities incurred at fair values. KCN receives cash of $400 and has a liability for the warranty servicing of $30 (regardless if the warranty servicing will be outsourced or not). The excess of assets received over liabilities….....

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