Question

TrueTech enters into a contract with ProSport Gaming to add ProSport's online games to the Tri-Net network. ProSport offers popular games like Brawl of Bands, and wants those games offered on the Tri-Net so ProSport can sell gems, weapons, health potions, and other game features that allow players to advance more quickly in a game.

The terms of the contract are:
On January 1, 2016, ProSport pays TrueTech an up-front fixed fee of $300,000 for six months of featured access.
ProSport also will pay TrueTech a bonus of $180,000 if Tri-Net users access ProSport games for at least 15,000 hours during the six-month period.
TrueTech estimates a 75% chance that it will achieve the usage target and receive the $180,000 bonus.

Requirement: Determine transaction price and recognize revenues using 1) expected value and 2) mostly like amount estimation.

Answer 1

To estimate the transaction price for TrueTech's contract with ProSport, we apply the expected value method by calculating the weighted bonus based on the likelihood of achieving the usage target,

and the most likely amount method by selecting the single most probable outcome regarding the bonus recognition.

Step-by-step explanation:

The student's question focuses on determining the transaction price and recognizing revenues based on two valuation methods:

expected value and most likely amount estimation. When calculating the transaction price for TrueTech's contract with ProSport, we consider the up-front fixed fee and the potential bonus.

Using the expected value method, we consider the probability of reaching the usage target and calculate the weighted revenue.

Alternatively, the most likely amount estimation would consider the single most likely outcome, which, in this scenario, assumes no bonus unless TrueTech is almost certain to meet the target.

We apply the expected value method as follows:

Using the most likely amount method:

If TrueTech estimates a 75% chance of reaching the target, it could recognize the full bonus: Add $180,000 bonus to the $300,000 fixed fee for a total transaction price of $480,000. However, if there is uncertainty and they do not expect to meet the target, only the fixed fee of $300,000 is recognized.

The correct approach depends on TrueTech's confidence in reaching the usage threshold and applicable revenue recognition standards.