Case Scenario:
Phantasy, Inc. is a research and development company that primarily develops and patents products. Phantasy, Inc. then licenses other companies to produce and sell the products. In return, Phantasy, Inc. receives royalties from these companies.
In 2009, Phantasy, Inc. developed and patented a product and then licensed Thurber Company to produce and sell it. Thurber Company will pay royalties to Phantasy, Inc. based upon the amount of sales.
Phantasy, Inc. and Sumi, Inc., another independent company, have agreed to the following:
Sumi, Inc. will pay Phantasy, Inc. $2,000,000 in 2009 and $3,500,000 in 2010.
These payments are non-refundable.
In return, Phantasy, Inc. will give Sumi, Inc. 17% of the royalties Phantasy, Inc. receives during the years 2010-2015 from Thurber Company for the above product.
In the case that the total amount paid by Phantasy, Inc. to Sumi, Inc. exceeds $7,500,000, the percentage of royalties paid by Phantasy, Inc. will drop from 17% to 5% on future royalties.
Phantasy, Inc. does not guarantee any payments to Sumi, Inc.
Sumi, Inc. estimates it expected rate of return to be approximately 35%.
Phantasy, Inc. will assume all responsibility and costs of protecting the patent against patent infringement and against all law suits asserting patent infringement. Phantasy, Inc. expects these costs to be minimal.
Additional information: In previous years, Sumi, Inc. has provided financing to Thurber Company for research and development. However, Sumi, Inc. did not provide financing for the current product.
Question: How should Phantasy, Inc. account for the receipt of the $2,000,000 and $3,500,000 payments?