Question

Allee Corp. is evaluating a revenue arrangement to determine proper revenue recognition. The contract is for construction of 10 speedboats for a contract price of $400,000. The customer needs the boats in its showrooms by February 1, 2018, for the boat purchase season; the customer provides a bonus payment of $21,000 if all boats are delivered by the February 1 deadline. The bonus is reduced by $7,000 each week that the boats are delivered after the deadline until no bonus is paid if the boats are delivered after February 15, 2018. Allee frequently includes such bonus terms in it contracts and thus has good historical data for estimating the probabilities of completion at different dates. It estimates an equal probability (25%) for each full delivery outcome. What approach should Allee use to determine the transaction price for this contract? Explain.

Answer 1

To determine the transaction price for the revenue arrangement, Allee Corp. should calculate the expected value of the bonus using the historical probabilities of meeting the completion dates. With equal probabilities (25%) for each delivery outcome, the total expected bonus is $10,500. Including the contract price of $400,000, the transaction price would be $410,500.

Step-by-step explanation:

To determine the transaction price for the contract, Allee Corp. should use the expected value method because the contract includes a variable consideration (the bonus payment), and the company has a robust set of historical data to estimate the probabilities of completing the project by certain dates. Under the expected value approach, Allee would calculate the probability-weighted amount to determine the transaction price. Given that there are equal probabilities (25%) for each delivery outcome, the expected bonus can be calculated by adding together the products of each bonus amount and its corresponding probability.

The calculation would look like this:

1. $21,000 bonus x 25% probability = $5,250
2. $14,000 bonus (reduced by $7,000) x 25% probability = $3,500
3. $7,000 bonus (reduced by $14,000) x 25% probability = $1,750
4. $0 bonus x 25% probability = $0

The total expected bonus would be the sum of these amounts, $5,250 + $3,500 + $1,750 + $0 = $10,500. Therefore, the transaction price Allee would recognize is the contract price of $400,000 plus the expected bonus of $10,500, resulting in a total of $410,500.