Question

On July 1, Wiggins Associates enters into a contract to provide consulting services to Pennsylvania University (PU). The contract is anticipated to last four months and is intended to achieve significant cost savings at the university. The contract stipulates that PU will pay Wiggins $42,000 at the end of each month, and, if total cost savings reach a specific target, PU will pay an additional $37,000 to Wiggins at the end of the contract. Wiggins estimates a 80% chance that cost savings will reach the target.
Assume that Wiggins estimates uncertain consideration as the most likely amount.

Required:
a. Prepare the journal entry on July 31 to record the first month of revenue under the contract.
b. Assuming total cost savings exceed the target, prepare the journal entry, if any, on October 31 to record receipt of the $33,000 bonus (ignore the normal October payment of $38,000).
c. Assuming total cost savings do not reach the target, prepare the journal entry, if any, on October 31 to record failure to receive the $33,000 bonus (ignore the normal October payment of $38,000).

Answer 1

Answer:

Explanation:

The possible amount to be received under the contract is (4 × $42,000) + $37,000  = $205,000 in as much that there is 75% possible chance that the $42,000 payment will be received. Thus, for each month Wiggins would receive $205,000/4 of the revenue = $51,250

Now, the Journal Entry is as follows:

Date              Particulars                Debit                Credit

July 31           Cash                                42,000  

                 Expected Bonus

                Receivable                              9250

              To Revenue                                                    51250

b) Over the first  six months, the expected bonus receivable will have accumulated to $37,000 ($9250 × 4). If Wiggins receive the bonus, we will have the entry as follows:

Date                   Particulars                Debit                Credit

October 31           Cash                        37,000  

                     Expected Bonus

                      Receivable                                              37,000

                    (being expected bonus

                   received at the end of

                      six months)

                 

c) After Six months, If Wiggins does not receive the bonus, we have the following entry :

Date              Particulars                Debit                Credit

October 31        Cash                        37,000  

                       Expected Bonus

                      Receivable                                              37,000

                  (being expected bonus

                  received at the end of

                   six months)