Question

Nash Financial Services performs bookkeeping and tax-reporting services to startup companies in the Oconomowoc area. On January 1, 20X1, Clarke entered into a 3-year service contract with Walleye Tech. Phillip promises to pay $10,800 at the beginning of each year, which at contract inception is the standalone selling price for these services. At the end of the second year, the contract is modified and the fee for the third year of services is reduced to $8,800. In addition, Phillip agrees to pay an additional $21,600 at the beginning of the third year to cover the contract for 3 additional years (i.e., 4 years remain after the modification). The extended contract services are similar to those provided in the first 2 years of the contract.

Instructions

(a) Prepare the journal entries for Nash in 20X1 and 20X2 related to this service contract, assuming that the annual revenue is recognized at year end. (4 journal entries)

(b) Prepare the journal entries for Nash in 20X3 related to the modified service contract, assuming a prospective approach. (2 journal entries).

Answer 1

On January 1, 20X1, Clarke entered into a 3-year service contract with Walleye Tech. Phillip promises to pay $10,800 at the beginning of each year, which at contract inception is the standalone selling price for these services. At the end of the second year, the contract is modified and the fee for the third year of services is reduced to $8,800. In addition, Phillip agrees to pay an additional $21,600 at the beginning of the third year to cover the contract for 3 additional years (i.e., 4 years remain after the modification). The extended contract services are similar to those provided in the first 2 years of the contract.

(i) Journal Entries for Nash related to this service contract:-

20X1-

Cash Dr $10800

To Unearned Revenue $10800

(Being $10800 revenue of service contract received related to Year 20X1)

Unearned Revenue Dr $10800

To Revenue $10800

(Being unearned revenue recognize as income in Profit and Loss A./c at year end)

20X2:-

Cash Dr $10800

To Revenue $10800

(Being $10800 revenue of service contract received related to Year 20X2)

Unearned Revenue Dr $10800

To Revenue $10800

(Being unearned revenue recognize as income in Profit and Loss A./c at year end)

(ii) Journal entries for Nash in 20X3 related to the modified service contract, assuming a prospective approach:-

20X3:-

Cash Dr $8800

To Revenue $8800

(Being revenue recognised)

Cash Dr $21600

To Unearned Revenue $21600

(Being additional $21600 received in advance )