Question

On January 1, Revis Consulting entered into a contract to complete a cost reduction program for Green Financial over a six-month period. Revis will receive $41,600 from Green at the end of each month. If total cost savings reach a specific target, Revis will receive an additional $20,800 from Green at the end of the contract, but if total cost savings fall short, Revis will refund $20,800 to Green. Revis estimates an 80% chance that cost savings will reach the target and calculates the contract price based on the expected value of future payments to be received.

Required:
Prepare the following journal entries for Revis:
1. to 3. Prepare the journal entry on January 31 to record the collection of cash and recognition of the first month’s revenue, assuming total cost savings exceed target, record the entry on June 30 for receipt of the bonus and assuming total cost savings fall short of target and record the entry on June 30 for payment of the penalty. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Answer 1

1. The contract requires 6 payments of $41,600, plus or minus $20,800 at the end of the contract. So the contract will provide either [(6 x $41,600) + $20,800] = $270,400, or [(6 x $41,600) – $20,800] = $228,800.

Revis would estimate the expected value of the transaction price as follows:

Possible Price	Probability	Expected Consideration
$270,400	80%	$216,320
$228,800	20%	$45,760
Expected value of contract price at inception		$262,080

Each month Revis will recognize $43,680 ($262,080 / 6) of revenue, recording the following journal entry:

Account	Debit	Credit
Cash	$41,600
Bonus receivable	$2,080
Service revenue		$43,680

2. After six months the bonus receivable will have accumulated to $12,480 (6 x $2,080). If Revis receives the bonus, it will record the following entry:

Account	Debit	Credit
Cash	$20,800
Bonus receivable		$12,480
Service revenue		$8,320

3. If Revis pays the penalty, it will record the following entry:

Account	Debit	Credit
Service revenue	$33,280
Bonus receivable		$12,480
Cash		$20,800