Summary Business Accounting

Question:

On January 1 Revis Consulting enters into a contract to complete a cost reduction program for Green

Financial over a six-month period. Green will pay Revis $20,000 at the end of each month. If total cost

savings reach a specific target, Green will pay an additional $10,000 to Revis at the end of the contract,

but if total cost savings fall short, Revis will refund $10,000 to Green. Revis estimates an 80% chance

that cost savings will reach the target and calculates the contract price based on the probability-weighted

amounts of future payments to be received. Revis accounts for this arrangement.

Required:

Prepare the following journal entries for Revis:

1. The journal entry on January 31 to record the first month of revenue under the contract.

2 Assuming total cost savings exceed target, the journal entry on June 30 to record receipt of the bonus.

3. Assuming total cost savings fall short of target, the journal entry on June 30 to record payment of the

penalty.



Answer:



Note: The contract requires 6 payments of $20,000, plus or minus $10,000 at the end of the life of the

contract. So the contract will provide either [(6  $20,000) – $10,000] = $110,000, or [(6  $20,000) +

$10,000] = $130,000.



a) Revis would estimate the transaction price as follows:



Possible Expected

Prices Probability Consideration



$130,000 ([$20,000  6] + $10,000) 80% $104,000