Question

Velocity, a consulting firm, enters into a contract to help Burger Boy, a fast-food restaurant, design a marketing strategy to compete with Burger King. The contract spans eight months. Burger Boy promises to pay $87,000 at the end of each month. At the end of the contract, Velocity either will give Burger Boy a refund of $29,000 or will be entitled to an additional $29,000 bonus, depending on whether sales at Burger Boy at year-end have increased to a target level. At the inception of the contract, Velocity estimates an 80% chance that it will earn the $29,000 bonus and calculates the contract price based on the expected value of future payments to be received. At the start of the fifth month, circumstances change, and Velocity revises to 60% its estimate of the probability that it will earn the bonus. At the end of the contract, Velocity receives the additional consideration of $29,000.
Required:
1) Prepare the journal entry to record revenue each month for the first four months of the contract.
2) Prepare the journal entry that the Velocity Company would record after four months to recognize the change in estimate associated with the reduced likelihood that the bonus will be received.
3) Prepare the journal entry to record the revenue each month for the second four months of the contract.
4) Prepare the journal entry after eight months to record receipt of the cash bonus.

Answer 1

Answer:

Accounts Receivable (Dr.) $87,000

Bonus receivable (Dr.) $29,000

Service Revenue (Cr.) $116,000

Explanation:

Expected Value at contract inception is :

($87,000 * 8 months + $29,000) * 80% = $580,000

($87,000 * 8 months - $29,000) * 20% = $133,400

Total = $713,400

$725,000 / 8 = $89,175

The service revenue is estimated to be 116,000 if there is no probability estimate. When the expected value is incorporated the service revenue will be $89,175.