Question

Emmet Property Management entered into a 2-year contract on June 1, 2016, to build an apartment building. The contract starts on July 1, 2016. Under the terms of the contract, Emmet will be paid a fixed fee of $1,500,000 and will receive an additional 10% of the fixed fee provided that building is ready to occupy at the end of the two years. Emmet estimates a 60% chance it will meet the completion date.

The total costs of the project are expected to be $1,200,000, and the costs to date (at the end of 2016) are $400,000.

1. What is the expected total transaction price for the full contract? (Assume the expected value approach to calculate the variable consideration.)

2. How much revenue should Emmet recognize on this contract in 2016? (Assume the cost-to-cost method.)

3. How much revenue should Emmet recognize on this contract in 2016? (Assume most-likely method.)

4. What is the effect on net income of using the expected-value approach versus the most-likely method?

Answer 1

Answer :

(a)

Total transaction price	$1500000
Add : Additional fixed fee @10%	$150000
Expected total transaction price	$1650000

(b). Revenue to be recognized on the contract 2016

= Cost incurred till date / Total expected cost

= $400000 / $1200000 = 33.33%

Total revenue to be recognized in 2016

= 33.33% of $1650000 - $400000

= $150000

(c) Revenue to be recognized in 2016

Probability for completion of work = 60%

60% of additional fee

= $150000*60%

= $90000

Total revenue to be recognized in 2016

= 33.33% of $1590000 - $400000

= $130000

(d). Effect on Net income from both method

Revenue from method one - method two

= $150000 - $130000

= $20000