Cybernetronics Inc. (Cyber) is a Canadian-owned public companywhich designs and manufactures communications and control systems.The company's year end is May 31. It is now June 2018.
You, CPA, are the manager for the audit of Cyber and yesterdayhad met with the treasurer to discuss the year-end audit. Thepartner responsible for this client has asked you to prepare areport for the client which discusses important financialaccounting issues and a memo to him regarding the audit issues youbelieve are important.
Notes from the Meeting with the Treasurer
- In December2017, Cyber won a $40 million contract to design autonomous robotsfor use in mining activities. In April 2018, the customer exercisedthe cancellation clause included in the contract. Cyber hascapitalized design and development costs related to this contract.The cancellation clause requires the mining company to pay apenalty of $12 million. The penalty has not yet been paid toCyber.
In June 2017, Cyber entered into anagreement with a university whereby Cyber received assistance inthe development of fuzzy logic software which was to have been usedin the robots designed for the contract with the mining company.The agreement requires Cyber to make an annual contribution of $0.5million to the university for four years. The first payment of $0.5million was made in March 2018 when the university's work wascompleted.
Management of Cyber is confident thatthe technology developed, including the fuzzy logic software, canbe applied to future contracts involving the design of robots.
Cyber entered into a five-year leaseon June 1, 2017 for facilities dedicated to the design and futuremanufacture of the robots for the mining company. Management ofCyber is presently negotiating a buy-out of the lease and hasoffered to make lump-sum payment of $750,000 to the lessor onSeptember 1, 2018. The annual lease payment is $500,000.
The draft balance sheet prepared forCyber's May 31 year end included capitalized design and developmentcosts in the amount of $8.2 million. This amount includes the $0.5million paid to the university. The draft income statement includesthe $12 million cancellation penalty as 'other income -- gain oncancellation of contract'.
*Identify the accounting and auditingissues*
