Question

Thomas Consultants provided Bran Construction with assistance in implementing various cost-savings initiatives. Thomas� contract specifies that it will receive a flat fee of $50,000 and an additional $20,000 if Bran reaches a prespecified target amount of cost savings. Thomas estimates that there is a 20% chance that Bran will achieve the cost-savings target. Required: 1. Assuming Thomas uses the expected value as its estimate of variable consideration, calculate the transaction price. 2. Assuming Thomas uses the most likely value as its estimate of variable consideration, calculate the transaction price. 3. Assume Thomas uses the expected value as its estimate of variable consideration, but is very uncertain of that estimate due to a lack of experience with similar consulting arrangements. Calculate the transaction price.

Answer 1

Concepts and reason

Cost-savings initiatives:

There are two factors to increase the profits of a business. One is to increase the sale price and the other is to reduce the cost.

In perfectly competitive markets, it is not prudent to increase the sales price as the customer can shift either to the substitute products or move to other company.

Therefore, every company tries to reduce the cost as much as possible by putting more efforts in finding and removing unwarranted expenses from the business.

Fundamentals

Expected value as its estimate:

Expected value is calculated taking into consideration the chances of achieving a target.

Most likely value as its estimate:

Most likely situation occurs when the probability of happening of an event is greater than the probability of not happening. Most likely situation is considered in the case when the chances of occurring an event is more than 50%.

1.

Calculate the transaction price as shown below:

2.

Using the most likely value as its estimate of variable consideration, calculate the transaction price as shown below:

Calculate the transaction price as shown below:

Ans: Part 1

Transaction price is $54,000.

Part 2

Transaction price is $50,000.

Part 3

Transaction price is $50,000.