Question

On January 1 Revis Consulting enters into a contract to complete a cost reduction program for Green Financial over a six-month period. Green will pay Revis $20,000 at the end of each month. If total cost savings reach a specific target, Green will pay an additional $10,000 to Revis at the end of the contract, but if total cost savings fall short, Revis will refund $10,000 to Green. Revis estimates an 80% chance that cost savings will reach the target and calculates the contract price based on the probability-weighted amounts of future payments to be received. Revis accounts for this arrangement.

 

Required:

Prepare the following journal entries for Revis:

1. The journal entry on January 31 to record the first month of revenue under the contract.

2. Assuming total cost savings exceed target, the journal entry on June 30 to record receipt of the bonus.

3. Assuming total cost savings fall short of target, the journal entry on June 30 to record payment of the penalty.

 

Answer 1

The contract requires 6 payments of $20,000, plus or minus $10,000 at the end of the life of the contract. So the contract will provide either [(6 $20,000) - $10,000] = $110,000, or [(6 $20,000) + $10,000] = $130,000.

 

1)             

Revis would estimate the transaction price as follows:

Possible				Expected
Prices			Probability	Consideration
$130,000	([$20,000	6] + $10,000)	80%	$104,000
$110,000	([$20,000	6] - $10,000)	20%	22,000
Expected contract price at inception				$126,000

 

Each month Revis would recognize $21,000 ($126,000 ÷ 6) of revenue, using the following journal entry:

 

Cash	20,000
Expected bonus receivable	1,000
Revenue	21,000

 

After six months the Expected bonus receivable will have accumulated to $6,000 (6 $1,000).

 

2)           

If Revis receives the bonus, it will record the following entry:

Cash	10,000
Expected bonus receivable	6,000
Revenue	4,000

 

3)           

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

Revenue	16,000
Expected bonus receivable	6,000
Cash	10,000

 

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

Revenue	16,000
Expected bonus receivable	6,000
Cash	10,000