Question

Gamma Ltd (Gamma) enters into a contract with a customer to provide 200 widgets at a price of $60 per widget. Under the contract terms, unused widgets may be returned within 30 days of sale for a full refund. Based on past experience, Gamma attaches the following probabilities to the estimated number of widgets the customer will return:

A. Under the 'expected value' method, the transaction price is $6120
B. Under the 'expected value' method, the transaction price is $10 260
C. Under the 'most likely amount' method, the transaction price is $6120
D. Under the 'most likely amount' method, the transaction price is $12 000

Answer 1

The answer details the difference between the expected value method and the most likely amount method regarding transaction price calculation and illustrates hypothetical scenarios on how they would be applied in determining Gamma Ltd.'s revenue from widget sales. The correct option is B. Under the 'expected value' method, the transaction price is $10,260.

Step-by-step explanation:

To accurately respond to this business question regarding revenue recognition, we need to clarify how to determine a company's transaction price for a contract considering product returns and the concepts of the expected value method versus the most likely amount method. Unfortunately, the original information provided with the probabilities for the number of widgets returned is not included here, so we cannot perform an exact calculation.

However, to determine the transaction price under the expected value method, one would calculate the weighted average of all possible outcomes by multiplying each amount by its respective probability and summing the results. With the most likely amount method, on the other hand, the company would determine the single most likely outcome and use that as the basis for revenue.

For example, if Gamma Ltd. predicted that there was a 10% chance of 10 widgets being returned and a 90% chance of no widgets being returned, the expected value method would use these probabilities to calculate the likely revenue. Alternatively, if the most likely outcome determined by Gamma Ltd. is that no widgets are going to be returned, then the transaction price would simply be the total price of the widgets sold without any adjustments for returns.