Question:
Velocity 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 $60,000 at the beginning of each month. At the end of the contract, Velocity either will give
Burger Boy a refund of $20,000 or will be entitled to an additional $20,000 bonus, depending on whether
sales at Burger Boy at the year-end has increased to a target level. At the inception of the contract,
Velocity estimates an 80% chance that it will earn the $20,000 bonus. After four months, circumstances
change and Velocity revises to 60% its estimate of the chance that it will earn the bonus. At the end of the
contract, Velocity receives the additional consideration of $20,000. Velocity accounts for this
arrangement.
Required:
1. Prepare a journal entry to record the revenue Velocity would recognize each month for the first four
months.
2. Prepare a journal entry that the Velocity Company would make after four months to record the change
in estimate associated with the likelihood that additional $20,000 would be received.
3. Prepare a journal entry to record the revenue that Velocity Company would recognize each month for
the second four months.
4. Prepare a journal entry after eight months to record resolution of the uncertainty associated with receipt
of the additional consideration of $20,000.
Answer:
Requirement 1
At the contract’s inception, Velocity would calculate the transaction price to be the probability-
weighted average of the two possible eventual prices:
Velocity 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 $60,000 at the beginning of each month. At the end of the contract, Velocity either will give
Burger Boy a refund of $20,000 or will be entitled to an additional $20,000 bonus, depending on whether
sales at Burger Boy at the year-end has increased to a target level. At the inception of the contract,
Velocity estimates an 80% chance that it will earn the $20,000 bonus. After four months, circumstances
change and Velocity revises to 60% its estimate of the chance that it will earn the bonus. At the end of the
contract, Velocity receives the additional consideration of $20,000. Velocity accounts for this
arrangement.
Required:
1. Prepare a journal entry to record the revenue Velocity would recognize each month for the first four
months.
2. Prepare a journal entry that the Velocity Company would make after four months to record the change
in estimate associated with the likelihood that additional $20,000 would be received.
3. Prepare a journal entry to record the revenue that Velocity Company would recognize each month for
the second four months.
4. Prepare a journal entry after eight months to record resolution of the uncertainty associated with receipt
of the additional consideration of $20,000.
Answer:
Requirement 1
At the contract’s inception, Velocity would calculate the transaction price to be the probability-
weighted average of the two possible eventual prices:
