Question

Emmet Property Management entered into a 2-year contract on June 1, 2016, to build an apartment building. The contract starts on July 1, 2016. Under the terms of the contract, Emmet will be paid a fixed fee of $1,500,000 and will receive an additional 10% of the fixed fee provided that building is ready to occupy at the end of the two years. Emmet estimates a 60% chance it will meet the completion date. The total costs of the project are expected to be $1,200,000, and the costs to date (at the end of 2016) are $400,000.

1. Under Option A, Emmet uses the expected value approach to calculate variable consideration. What is the expected total transaction price for the full contract under Option A?
2. And how much revenue should Emmet recognize on this contract in 2016 under option A? (Assume the cost-to-cost method.)
3. Under Option B, Emmet uses the most-likely method to calculate the variable consideration. What is the expected total transaction price for the full contract under Option B?
4. And how much revenue should Emmet recognize on the contract in 2016 under Option B? (Assume the cost-to-cost method.)
5. So, which option (A or B) results in a higher amount of net income in 2016?

Answer 1

Option A
Expected value appraoch
Case	Revenue	Probability	Amount
Meet completion date	1650000	60%	990000
	(1500000 + 10% of 1500000 )
Not Meet Completion date	1500000	40%	600000
Total Transaction Price			1590000
Revenue to be recognozed	Amount	%age of completion
Cost Incurred till date	400000	33.33
		(400000/1200000)
Revenue to recognized	530000
(Total Transaction Price * %age of completion	(1590000 * 33.33%)
Option B
Most likely appraoch
Case	Revenue	Probability	Amount
Meet completion date	1650000	100%	1650000
	(1500000 + 10% of 1500000 )
Total Transaction Price			1650000
Revenue to be recognozed	Amount	%age of completion
Cost Incurred till date	400000	33.33
		(400000/1200000)
Revenue to recognized	550000
(Total Transaction Price * %age of completion	(1650000 * 33.33%)

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