132k views
0 votes
Sanjeev enters into a contract offering variable consideration. The contract pays him $2,400/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $3,400 and a 40% chance the contract will pay an additional $4,400, depending on the outcome of the consulting contract. Sanjeev concludes that this contract qualifies for revenue recognition over time.

Assume that Sanjeev estimates variable consideration as the most likely amount. After Sanjeev has recognized revenue for two months of the contract, he changes his assessment of the chance the contract will pay him $4,400 to 70%. What adjustment to revenue should Sanjeev recognize to account for that change in estimate?

User Tomek
by
7.0k points

1 Answer

4 votes

Final answer:

Sanjeev should adjust the revenue recognized to reflect the increased likelihood of receiving the higher additional amount after changing his assessment. The adjustment would be an additional $75 per month for the remaining four months of the contract.

Step-by-step explanation:

The question is related to revenue recognition and accounting for changes in estimates of variable consideration. Originally, Sanjeev's contract indicated a 60% chance to receive an additional $3,400 and a 40% chance to receive an additional $4,400. After two months, Sanjeev reassesses the likelihood of receiving the higher amount ($4,400) to 70%. To account for this change, Sanjeev needs to adjust the revenue recognized in the financial statements.

Originally, the expected variable consideration was:
(0.6 \* $3,400) + (0.4 \* $4,400) = $2,040 + $1,760 = $3,800.

After reassessment, the expected variable consideration is:
(0.3 \* $3,400) + (0.7 \* $4,400) = $1,020 + $3,080 = $4,100.

The adjustment to revenue is the difference between the new and the old estimates, divided by the remaining performance obligation period after the adjustment.
($4,100 - $3,800) = $300 over 4 months (since two months have already been recognized) = $75 per month.

Thus, Sanjeev should recognize an additional $75 per month for the remaining four months to accurately reflect the change in estimate.

User Rharter
by
8.4k points