Question

1. 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 $68,000 from Green at the end of each month. If total cost savings reach a specific target, Revis will receive an additional $34,000 from Green at the end of the contract, but if total cost savings fall short, Revis will refund $34,000 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. Also record the entry on June 30 for receipt of the bonus assuming total cost savings exceed target. And record the entry on June 30 for payment of the penalty assuming total cost savings fall short of target. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

2. Video Planet (VP) sells a big screen TV package consisting of a 60-inch plasma TV, a universal remote, and on-site installation by VP staff. The installation includes programming the remote to have the TV interface with other parts of the customer’s home entertainment system. VP concludes that the TV, remote, and installation service are separate performance obligations. VP sells the 60-inch TV separately for $2,130 and sells the remote separately for $290, and offers the entire package for $2,660. VP does not sell the installation service separately. VP is aware that other similar vendors charge $340 for the installation service. VP also estimates that it incurs approximately $290 of compensation and other costs for VP staff to provide the installation service. VP typically charges 30% above cost on similar sales.

Required:
1. to 3. Calculate the stand-alone selling price of the installation service using each of the following approaches.
a) adjusted market assessment, b) expected cost plus margin, c) residual

Answer 1

Q1.

Journal entries

Working:

31-Jan:

The contract requires 6 payments of $68,000, plus or minus $34,000 at the end of the contract. So the contract will provide either [(6 x $68,000) + $34,000] = $442,000, or [(6 x $68,000) – $34,000] = $374,000.

Each month Revis will recognize $71,400 ($428,400 / 6) of revenue

Therefore bonus = $71,400 - $68,000 = $3,400

30-Jun:

After six months the bonus receivable will have accumulated to $ 20,400 (6 x $3,400).

.

Q2.

The stand-alone price of the installation service under the three approaches should be determined as follows:

1.

Adjusted market assessment

Under this approach, the prevailing market price of the service should be considered referencing the prices charged by the competitor for similar services.

Other similar service vendors charge $ 340 for the installation service. Therefore, the stand-alone price of the installation service under an adjusted market assessment approach would be $ 340.

2.

Expected cost plus margin

Under this approach, the cost of satisfying the performance obligation should be estimated first and then an appropriate margin should be added to it.

The company incurs $290 of compensation and other costs for staff to provide the installation service and charges 30% above cost on similar sales. Therefore, the stand-alone price of the installation service under the expected cost plus margin approach would be $ 377 ( 290 + (290 x 30%)).

3.

Residual

Under this approach, the known stand-alone selling price of other goods and services should be subtracted from the total transaction price in the contract.

Stand-alone selling price for TV = $2,130

Stand-alone selling price for remote = $290

Total transaction price = $2,660

Therefore,

Stand-alone selling price for installation service = $2,660 - $2,130 - $290 = $ 240.