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 $81,000 at the end of each month. At the end of the contract, Velocity either will give Burger Boy a refund of $27,000 or will be entitled to an additional $27,000 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 $27,000 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 $27,000. Required: 1. to 4. 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.) View transaction list Journal entry worksheet Record the entry to record revenue each month for the first four months of the contract. Note: Enter debits before credits.

Answer 1

Answer:

Transaction	General Journal	Debit ($)	Credit ($)
1	Accounts receivable	81,000
	Bonus receivable (See note 1 below)	2,025
	Service revenue (81000 +2025)		83,025
	(To record revenue for first four months)
2	Service revenue	5,400
	Bonus receivable (See note 2 below)		5,400
	(To adjust the reduced likelihood of bonus)
3	Accounts receivable	81,000
	Bonus receivable (See note 2 below)	675
	Service revenue (54,000+450)		81,675
	(To record revenue for second four months)
4	Cash	27,000
	Bonus Receivable ($675*8 months)		5,400
	Service Revenue (27000-5400)		21,600
	(To record the receipt of bonus after eight months)

Notes:-

1) Calculation of expected value of contract at the inception of contract:-

Possible Prices (A)	Probabilities (B)	Expected Consideration (A*B)
[(81000*8)+$27000]	80%	540,000
[(81000*8)-$27000]	20%	124,200
Expected value at contract inception		664,200

Bonus receivable at the inception = Total Expected value - Total monthly payments

= $664200 - (81000*8) = $16,200

Bonus to be recognized per month over 8 months = $16200/8 months = $2025

2) Calculation of new expected value of contract after four months :-

Possible Prices (A)	Probabilities (B)	Expected Consideration (A*B)
[(81000*8)+$27000]	60%	405,000
[(81000*8)-$27000]	40%	248,400
Expected value at contract inception		653,400

New expected Bonus receivable = Total Expected value - Total monthly payments

= $653,400 - (81000*8) = $5,400

Bonus to be recognized per month over 8 months = $5,400/8 months = $675

Excess bonus recognized for first 4 months = $2025- $675= $900 per month

The amount of bonus to be reversed after the end of four months is $5,400 ($1350*4 months).