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 $51,200 from Green at the end of each month. If total cost savings reach a specific target, Revis will receive an additional $25,600 from Green at the end of the contract, but if total cost savings fall short, Revis will refund $25,600 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. Prepare the journal entry on January 31 to record the collection of cash and recognition of the first month’s revenue. Also record the entry on June 30 for receipt of the bonus assuming total cost savings exceed target. And record the entry on June 30 for payment of the penalty assuming total cost savings fall short of target

Answer 1

Solution:-

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

Possible Price	Possibility	Expected Amount
$332,800 ($51,200*6 + $25,600)	80%	266,240
$281,600 ($51,200*6 - $25,600)	20%	56,320
Expected Value		322,560

Accounts	Debit	Credit
Cash	51,200
Bonus Receivable	2,560
Service Revenue (322,560 / 6)		53,760

2. Also record the entry on June 30 for receipt of the bonus assuming total cost savings exceed target:-

Accounts	Debit	Credit
Cash	25,600
Bonus Receivable (2,560 * 6)		15,360
Service Revenue		10,240

3. And record the entry on June 30 for payment of the penalty assuming total cost savings fall short of target:-

Accounts	Debit	Credit
Service Revenue	79,360
Bonus Receivable (322,560 / 6)		53,760
Cash		25,600

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