Question

on june 1, 2021, montana corp. entered into a 2 year contract to provide maintenance services for equipment it sells. the contract starts on july 1, 2021. the contract details that montana will be paid a fixed fee of $50,000 per year and will receive an additional 15% of the fixed fee at the end of each year provided that equipment breakdown time is below 10%. montana estimates 30% chance that the equipment will break down at a rate below threshold (less than 10% of the time), inconclusive revenue recognition overtime is appropriate for this contract. how much revenue should montana recognize on this contract in 2021 using the expected value method for variable consideration?

Answer 1

Montana Corp. should recognize a total of $27,250 in revenue for the year 2021, calculated by combining the prorated fixed fee of $25,000 for six months of service with the expected variable bonus of $2,250 using the expected value method.

Step-by-step explanation:

The question you asked is about revenue recognition for a contract using the expected value method. To calculate the revenue that Montana Corp. should recognize in 2021, we start with the fixed annual fee of $50,000. Since the contract started on July 1, 2021, only six months of service, or half of the annual fee, should be recognized in 2021, which is $25,000.

The additional 15% bonus is contingent on equipment performance; Montana estimates a 30% chance that the bonus condition will be met. To find the expected value of the variable consideration, we multiply the potential bonus ($7,500, which is 15% of the fixed fee) by the probability of occurrence (30%). This amounts to an expected bonus of $2,250 for the year.

Therefore, Montana should recognize a total revenue of $27,250 for the year 2021, consisting of the prorated fixed fee and the expected value of the variable consideration.