Question

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

Part 2) Record the entry at the start of fifth month, to recognize the charge in estimate associated with the reduced likelihood that the $24,000 bonus will be received.

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

part 4) Record the entry eight months to record receipt of the $24,000 bonus.

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 $72,000 at the end of each month. At the end of the contract, Velocity either will give Burger Boy a refund of $24,000 or will be entitled to an additional $24,000 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 $24,000 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 $24,000.

Answer 1

1) Firstly we need to calculate expected consideration at the beginning of the contract which is calculated as follows:-

Calculation of expected consideration (Amounts in $)

Possible prices (a)	Probabilities (b)	Expected Consideration (a*b)
600,000 [(72,000*8 months)+24,000]	80%	480,000
552,000 [(72,000*8 months)-24,000]	20%	110,400
Total Expected Value		590,400

Total Bonus receivable = Expected consideration - Total service revenue for 8 months

= $590,400 - (72,000*8)

= $590,400 - $576,000 = $14,400

Bonus to be recognized each month = $14,400/8 months = $1,800 per month

The journal entry for the first four months is shown as follows:- (Amounts in $)

No	Account Titles and Explanations	Debit	Credit
1	Accounts Receivable	72,000
	Bonus Receivable	1,800
	Service Revenue (72,000+1,800)		73,800
	(To record the service revenue for first four months)

2) For recognizing change in estimated, we need to recalculate the expected consideration with the revised estimated probabilities which is shown as follows:-

Calculation of expected consideration (Amounts in $)

Possible prices (a)	Probabilities (b)	Expected Consideration (a*b)
600,000 [(72,000*8 months)+24,000]	60%	360,000
552,000 [(72,000*8 months)-24,000]	40%	220,800
Total Expected Value		580,800

Total Bonus receivable = Expected consideration - Total service revenue for 8 months

= $580,800 - (72,000*8)

= $580,800 - $576,000 = $4,800

Bonus to be recognized each month = $4,800/8 months = $600 per month

Total bonus recognized for first four months = $1,800*4 months = $7,200

Bonus that should be recognized = $600*4 months = $2,400

Bonus to be reduced = $7,200-$2,400 = $4,800

The journal entry for the recognize the change in estimate (Amounts in $)

No	Account Titles and Explanations	Debit	Credit
2	Service Revenue	4,800
	Bonus Receivable		4,800
	(To record change in estimate)

3) The journal entry for the second four months is shown as follows:- (Amounts in $)

No	Account Titles and Explanations	Debit	Credit
1	Accounts Receivable	72,000
	Bonus Receivable	600
	Service Revenue (72,000+600)		72,600
	(To record the service revenue for second four months)

4) The journal entry to record the receipt of bonus (Amounts in $)

No	Account Titles and Explanations	Debit	Credit
1	Cash	24,000
	Bonus Receivable (600*8 months)		4,800
	Service Revenue (24,000-4,800)		19,200
	(To record the receipt of bonus)