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 $69,000 at the end of each month. At the end of the contract, Velocity either will give Burger Boy a refund of $23,000 or will be entitled to an additional $23,000 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 $23,000 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 $23,000.

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.)

1. Record the entry to record revenue each month for the first four months of the contract.

2. Record the entry at the start of fifth month, to recognize the change in estimate associated with the reduced likelihood that the $23,000 bonus will be received.

3. Record the entry to record revenue each month for the second four months of the contract.

4. Record the entry after eight months to record receipt of the $23,000 bonus.

Answer 1

Solution Contract - 8 month receives $69000 each month May be : refund $23000 receive bonus $23000 Begin. of contri 80% chance to earn $23000 benus after 4 month: 60% u u u "1 " End of contact : $ 23000 at the contract's inception, Velocity calculates the transaction price to be expected value of two possible eventual prices: - Expeeted Possible Prices Probabilities Consideration (969000x8)+ $ 23000) x 80% --- $460000 C8 69000 X 8) - $23000) X 20%- $ 105,800 Expected value at contract inception: 565800 because its consulting services are provided evenly ouer a & moriths Velocity will recognise revenue of $70725 (565800 & 8). because Velocity is guaranteed to receive amly $69000 per month ($ 1725 less than revenue recognised), it will recognise bonus of $1725 each month to reflect expected bonus value amount to be received at end of contract this journal entry will be ! - Accounts receivable 69000 Bonus receivable 1,725 I service Revenue 70725

after 4 month. 6oy chance to earn $23000 bonus End of contract, receives $23000 by end of 4th month, bonus receivable account would have a balance of ($1725x4) $6900, equal to half of expected value of boners of $13800 (856 5800 - (6900048). After 4 months, the estimated likelihood of receiving bonus is received so estimated transaction Expected fossible prices Probabilities Consideration € 469000+ 8) +$23000)) x 60% = 345,000 (C$69000 x 8) - $23000)] x 40% = 211600 transaction price after 4 months: $ 55 6600 de creases - So after 4 months, the bonus receivable alo should have a balance of $2300, which is half of expected value of bonus of of 600 (55660o - (8x $69000)) Becourse bonus receivable alc was increased $6900 in the first 4 months, an adjustment of $4600 is needed to reduce bonus receivable no $23.00 Service Revenue 46oo Bonus Receivable this entry reduces the bonus receivable from $6900 to $2300, with offsetting debit being a reductime Over remaining 4 months, the bonus receivable will increase by $575 each month, accomulation to $4600 at the end of contract 460o.

3.Because services are provided evenly over the eight months, Velocity would recognize revenue of $69,575($556,600 ÷ 8 months) in each of months five through eight. BecauseVelocity received $69,000 per month ($575 less than the revenue recognized), Velocity wouldrecognize a bonus receivable of $575 each month to reflect the additional service revenue inexcess of its unconditional right to $69,000.

The Journal entry would be ! - Accounts receivable 69,000 Bonus receivable 575 Service Revenue 69575 At the end & the contract, Velocity learns that it will receive the benus of $23000. It already has recognised revenue of $4600 associated with bones. therefore, when velocity receives the cash bonus, it will recognise additional revenue of $184001 23000 Bonus receivable Service Revenue Cash 4,600 18400