Question

On January 1 Revis Consulting enters into a contract to complete a cost reduction program for Green Financial over a six-month period. Green will pay Revis $20,000 at the end of each month. If total cost savings reach a specific target, Green will pay an additional $10,000 to Revis at the end of the contract, but if total cost savings fall short, Revis will refund $10,000 to Green. Revis estimates an 80% chance that cost savings will reach the target and calculates the contract price based on the probability-weighted amounts of future payments to be received. Revis accounts for this arrangement.
Prepare the following journal entries for Revis:

1. The journal entry on January 31 to record the first month of revenue under the contract.

2. Assuming total cost savings exceed target, the journal entry on June 30 to record receipt of the bonus.

3. Assuming total cost savings fall short of target, the journal entry on June 30 to record payment of the penalty

Answer 1

Answer:

Explanation:

1. The journal entry on January 31 to record the first month of revenue under the contract.

Dr Cash 20,000

Dr Bonus receivables 1000

    Cr Service revenue 21,000

How to calculate service revenue:

Total savings if the target is achieved = Monthly receipts * period + additional revenue = 20,000*6 + 10,000 = 130,000

Total revenue if the target is not achieved = Monthly receipts * period - additional revenue = 120,000 - 10,000 = 110,000

Monthly revenue = (130,000*0.80 + 110,000*0.20)/6 = 126,000/6 = 21,000

2. Assuming total cost savings exceed target, the journal entry on June 30 to record receipt of the bonus.

Dr Cash 10,000

    Cr Bonus receivables 6,000

    Cr Service revenue 4,000

How to calculate bonus receivables:

Bonus receivables= monthly bonus receivables * period = 1000*6 = 6,000

3.Assuming total cost savings fall short of target, the journal entry on June 30 to record payment of the penalty.

Dr Service revenue 16,000

    Cr Bonus receivables 6,000

    Cr Cash 10,000