Question

Velocity, a consulting firm, enters into a contract to help Burger Boy, a fast-food restaurant, design a marketing strategy to compete with Burger King. The contract spans eight months. Burger Boy promises to pay $78,000 at the end of each month. At the end of the contract, Velocity either will give Burger Boy a refund of $26,000 or will be entitled to an additional $26,000 bonus, depending on whether sales at Burger Boy at year-end have increased to a target level. At the inception of the contract, Velocity estimates an 80% chance that it will earn the $26,000 bonus and calculates the contract price based on the expected value of future payments to be received. At the start of the fifth month, circumstances change, and Velocity revises to 60% its estimate of the probability that it will earn the bonus. At the end of the contract, Velocity receives the additional consideration of $26,000.

Required:
1. Prepare the journal entries related to the contract (If no entry is required for a transaction/event, select "No journal entry required in the first account field).
2. Record the entry to record revenue each month for the first four months of the contract.
3. Record the entry at the start of the fifth month to recognize the change in estimate associated with the reduced likelihood that the s14,000 bonus will be received.
4. Record the entry after eight months to record receipt of the $14,000 bonus.

Answer 1

1. Possible prices (A) Prob. (B) Exp. consideration (A*B)

[($78,000*8m)+$26,000] $650,000 80% $520,000

[($78,000*8m)-$26,. 000] $598,000 20% $119,600

Expected value at contract inception $639,600

Date General Journal Debit Credit

Accounts Receivable $78,000

Bonus Receivable $1,950

Service Revenue $79,950

($639,000/8 months)

(To record the service revenue for the first four months)

2. Possible prices (A) Prob. (B) Exp. consideration (A*B)

[($78,000*8m)+$26,000] $650,000 60% $390,000

[($78,000*8m)-$26,. 000] $598,000 40% $239,200

Transaction price after four months $629,200

Date General Journal Debit Credit

Service Revenue $5,200

Bonus Receivable $5,200

([$629,200 - ($78,000*8 months)]

(To adjust the excess amount of bonus)

3. Date General Journal Debit Credit

Accounts Receivable $78,000

Bonus Receivable $650

Service Revenue $78,650

($629,200/8 months)

(To record the service revenue for the last four months)

4. Date General Journal Debit Credit

Cash $26,000

Bonus Receivable $5,200

Service Revenue $20,800

(To record the receipt of bonus)