Question

1. On January 1, Revis Consulting entered into a contract to complete a cost reduction program for a client over a six-month period. Revis will receive $40,000 from the client at the end of each month. If total cost savings reach a specific target, Revis will receive an additional $40,000 bonus from the client at the end of the contract. However, if total cost savings fall short of the target, Revis must refund $40,000 to the customer. Revis estimates a 80% chance that cost savings will meet the target and calculates the contract price based on the expected value of future payments to be received. (1) What is the amount of revenue that Revis expects to earn from this contract? (2) How much should be recognized in January? (3) Prepare the journal entry on January 31 to record the collection of cash and recognition of the first month’s revenue. (Round your answer to the closest dollar.)

Answer 1

Expected value of bonus for the six months: 80%*40,000+20%*(-40,000) = $24,000
Expected bonus allocated to the first month: $24,000/6 = $4,000
Cash a/c                                     Dr.			40000
Bonus receivable a/c            Dr.			4000
To Service revenue				44000