Question

Velocity, a consulting firm, enters into a contract to help Burger Boy, a fast-food restaurant, design a marketing strategy to compete with Burger King. The contract spans eight months. Burger Boy promises to pay $60,000 at the beginning of each month. At the end of the contract, Velocity either will give Burger Boy a refund of $20,000 or will be entitled to an additional $20,000 bonus, depending on whether sales at Burger Boy at yearend have increased to a target level. At the inception of the contract, Velocity estimates an 80% chance that it will earn the $20,000 bonus and calculates the contract price based on the expected value of future payments to be received. After four months, circumstances change, and Velocity revises to 60% its estimate of the probability that it will earn the bonus. At the end of the contract, Velocity receives the additional consideration of $20,000. 

 

Required: 

1. Prepare the journal entry to record revenue each month for the first four months of the contract. 

2. Prepare the journal entry that the Velocity Company would record after four months to recognize the change in estimate associated with the reduced likelihood that the $20,000 bonus will be received. 

3. Prepare the journal entry to record the revenue each month for the second four months of the contract. 

4. Prepare the journal entry after eight months to record receipt of the $20,000 cash bonus.

 

Answer 1

Variable consideration:

 

Requirement: 1

Calculation of expected value (1):

It is given that the revenue is $60,000, cost of saving is $20,000, and number of payments is 8.

 

Now, calculate the expected value:

Expected value = {(Revenue × Number of payments) + Cost of saving}

                         = ($60,000 × 8) + $20,000)

                         = $480,000 + $20,000

                         = $500,000

 

Hence, the calculated expected value is $500,000.

 

Calculation of expected value (2):

It is given that the revenue is $60,000, cost of saving is $20,000, and number of payments is 8.

 

Now, calculate the expected value:

Expected value = {(Revenue × Number of payments) - Cost of saving}

                         = ($60,000 × 8) - $20,000)

                         = $480,000 + $20,000

                         = $460,000

 

Hence, the calculated expected value is $460,000.

 

Calculation of expected contract price:

It is given that the revenue is $60,000, cost of saving is $20,000, and number of payments is 8.

 

Now, calculate the expected contract price:

Expected value	Probability	Expected consideration
$500,000 (Refer to equation (1))	80%	$400,000 ($110,000 × 80%)
$460,000(Refer to equation (2))	20%	$92,000 ($110,000 × 20%)
Expected contract price	$492,000

 

Hence, the calculated expected contract price is $492,000.

 

Calculation of service revenue:

The calculated expected contract price is $492,000 and number of payments is 8.

 

Now, calculate the service revenue:

Service revenue = (Expected contract price/Number of payments)

                          = $492,000/8

                          = $61,500

 

Hence, the calculated service revenue is $61,500.

 

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$60,000
	Bonus receivable		$1,500
	Service revenue (Refer to equation (3))			$61,500
	(To record service performed)

 

• Cash and bonuses receivable are asset. There is an increase in asset value. Therefore, it is debited.

• Service revenue is revenue. There is an increase in liability value. Therefore, it is credited.

 

Requirement: 2

Calculation of expected value (1):

It is given that the revenue is $60,000, cost of saving is $20,000, and number of payments is 8.

 

Now, calculate the expected value:

Expected value = {(Revenue × Number of payments) + Cost of saving}

                         = ($60,000 × 8) + $20,000)

                         = $480,000 + $20,000

Expected value = $500,000 ………………………………..… (4)

 

Hence, the calculated expected value is $500,000.

 

Calculation of expected value (2):

It is given that the revenue is $60,000, cost of saving is $20,000, and number of payments is 8.

 

Now, calculate the expected value:

Expected value = {(Revenue × Number of payments) + Cost of saving}

                         = ($60,000 × 8) - $20,000)

                         = $480,000 - $20,000

Expected value = $$460,000 ………………………………….. (5)

 

Hence, the calculated expected value is $460,000.

 

Calculation of expected contract price:

It is given that the revenue is $60,000, cost of saving is $20,000, and number of payments is 8.

 

Now, calculate the expected contract price:

Expected value	Probability	Expected consideration
$500,000 (Refer to equation (4))	60%	$300,000($110,000 × 80%)
$460,000(Refer to equation (5))	40%	$184,000($110,000 × 20%)
Expected contract price	$484,000

 

Hence, the calculated expected contract price is $484,000.

 

Calculation of bonus receivable:

It is given that the revenue is $60,000, number of payments is 8, and calculated expected contract price is $484,000.

 

Now, calculate the bonus receivable:

Bonus receivable = {Expected contract price – (Revenue 0064 Number of payments)}

                             = $484,000 – ($60,000 × 8)

                             = $484,000 – $480,000

Bonus receivable = $4,000 ……………………………………. (6)

 

Hence, the calculated bonus receivable is $4,000.

 

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Service revenue		$4,000
	Bonus receivable (Refer to equation (6))			$4,000
	(To record offsetting adjustment in revenue)

 

• Service revenue is revenue. There is a decrease in liability value. Therefore, it is debited.

• Bonuses receivable is an asset. There is a decrease in asset value. Therefore, it is credited.

 

Requirement: 3

Calculation of service revenue:

The calculated expected contract price is $484,000 and number of payments is 8.

 

Now, calculate the service revenue:

Service revenue = (Service revenue/Number of payments)

                          = $484,000/8

Service revenue = $60,500 …………………………… (7)

 

Hence, the calculated service revenue is $60,500.

Journal entry:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Accounts receivable		$60,000
	Bonus receivable		$500
	Service revenue (Refer to equation (7))			$60,500
	(To record offsetting adjustment in revenue)

 

• Accounts receivable and bonus receivable is an asset. There is an increase in asset value. Therefore, it is debited.

• Service revenue is revenue. There is an increase in liability value. Therefore, it is credited.

 

Requirement: 4

Calculation of service revenue:

It is given that the bonus accumulated is $4,000 ($500×8) and expected bonus is $20,000.

 

Now, calculate the service revenue:

Service revenue = (Expected bonus – Bonus accumulated)

                           = $20,000 - $4,000

Service revenue = $16,000 ………………………………… (8)

 

Hence, the calculated service revenue is $16,000.

 

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$20,000
	Bonus receivable			$4,000
	Service revenue (Refer to equation (8))			$16,000
	(To record service performed)

 

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.

• Bonus receivable is an asset. There is an increase in asset value. Therefore, it is debited.

• Service revenue is revenue. There is an increase in liability value. Therefore, it is credited.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash		$20,000
	Bonus receivable			$4,000
	Service revenue (Refer to equation (8))			$16,000
	(To record service performed)

 

• Cash is an asset. There is an increase in asset value. Therefore, it is debited.

• Bonus receivable is an asset. There is an increase in asset value. Therefore, it is debited.

• Service revenue is revenue. There is an increase in liability value. Therefore, it is credited.