Question

On January 1 Revis Consulting entered into a contract to complete a cost reduction program for Green Financial over a six-month period. Revis will receive $24,800 from Green at the end of each month. If total cost savings reach a specific target, Revis will receive an additional $12,400 from Green at the end of the contract, but if total cost savings fall short, Revis will refund $12,400 to Green. Revis estimates an 80% chance that cost savings will reach the target and calculates the contract price based on the expected value of future payments to be received.
Required:
Prepare the following journal entries for Revis:
1. to 3.
1. Prepare the journal entry on January 31 to record the collection of cash and recognition of the first month’s revenue,
2. Assuming total cost savings exceed target, record the entry on June 30 for receipt of the bonus and3. Assuming total cost savings fall short of target and record the entry on June 30 for payment of the penalty.

Answer 1

Answer:

1. Prepare the journal entry on January 31 to record the collection of cash and recognition of the first month’s revenue,

January 31

Dr Cash 24,800

Dr Bonus receivables 1,240

    Cr Service  revenue 26,040

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

June 30

Dr Cash 12,400

    Cr Service  revenue 4,960

    Cr Bonus receivables 7,440

3. Assuming total cost savings fall short of target and record the entry on June 30 for payment of the penalty.

Dr Service revenue 19,840

    Cr Bonus receivables 7,440

    Cr Cash 12,400

Explanation:

service revenue:

• if target is achieved = ($24,800 x 6) + $12,400 = $161,200
• If target is not achieved = ($24,800 x 6) - $12,400 = $136,400

monthly revenue = [($161,200 x 80%) + ($136,400 x 20%)] / 6 = $128,960 + $27,280) / 6 = $26,040

The difference between monthly payment and monthly revenue must be recorded as bonus receivables.