Allee Corp evaluates a revenue arrangement to determine proper revenue recognition. The contract is for the construction of 10 speedboats for a contract price of \(400,000. The customer needs the boats in its showrooms by February 1, 2018, for the boat purchase season; the customer provides a bonus payment of \)21,000 if all ships are delivered by the February 1 deadline. The bonus is reduced by $7,000 each week that the boats are delivered after the deadline until no compensation is paid if the ships are provided after February 15, 2018. Allee frequently includes such bonus terms in its contracts and thus has good historical data for estimating the probabilities of completion at different dates. It calculates an equal likelihood (25%) for each delivery outcome. What approach should Allee use to determine the transaction price for this contract? Explain.

Transaction cost is the amount an organization receives from billed customers for transferring a promised product or service. This transaction value must be pre-determined and agreed upon by both parties.

Management's estimate of the amount of consideration to which the entity will be entitled should be included in the transaction price. Probability-weighted technique is the best predictive way for estimating the variable under examination, given the different possibilities and probabilities available based on experience. In this instance:

The contract price for 10 speedboats = $400,000

The likelihood for each outcome = 25%

In the first situation:

Bonus payment till 1 February = $21,000

If boats are delivered by February 1, 2018, the chance of getting $421,000.

$\begin{array}{rcl}\mathrm{Variable}\mathrm{consideration}1& =& \mathrm{Likelihood}\mathrm{for}\mathrm{outcome}\times \mathrm{Contract}\mathrm{price}+\mathrm{Bonus}\mathrm{payment}\\ & =& 25\%\times \$400,000+\$21,000\\ & =& \frac{25}{100}\times \$421,000\\ & =& \$105,200\end{array}$

In the second situation:

Bonus payment till 8 February = $14,000

If boats are delivered by February 8, 2018, the chance of getting $414,000

$\begin{array}{rcl}\mathrm{Variable}\mathrm{Consideration}2& =& \mathrm{Likelihood}\mathrm{for}\mathrm{outcome}\times \mathrm{Contract}\mathrm{price}+\mathrm{Bonus}\mathrm{payment}\\ & =& 25\%\times \$400,000+\$14,000\\ & =& \frac{25}{100}\times \$414,000\\ & =& \$103,500\end{array}$

In the third situation:

Bonus payment till 15 February = $7,000

If boats are delivered by February 15, 2018, the chance of getting $407,000.

$\begin{array}{rcl}\mathrm{Variable}\mathrm{consideration}3& =& \mathrm{Likelihood}\mathrm{for}\mathrm{outcome}\times \mathrm{Contract}\mathrm{price}+\mathrm{Bonus}\mathrm{payment}\\ & =& 25\%\times \$400,000+\$7,000\\ & =& \frac{25}{100}\times \$407,000\\ & =& \$101,750\end{array}$

In the fourth situation:

Bonus payment after 15 February = $ 0

If boats are delivered after February 15, 2018, the chance of getting $400,000

$\begin{array}{rcl}\mathrm{Variable}\mathrm{consideration}4& =& \mathrm{Likelihood}\mathrm{for}\mathrm{outcome}\times \mathrm{Contract}\mathrm{price}+\mathrm{Bonus}\mathrm{payment}\\ & =& 25\%\times \$400,000+\$0\\ & =& \frac{25}{100}\times \$400,000\\ & =& \$100,000\end{array}$

$\begin{array}{rcl}\mathrm{Total}\mathrm{transaction}\mathrm{price}& =& \mathrm{VC}1+\mathrm{VC}2+\mathrm{VC}3+\mathrm{VC}4\\ & =& \$105,250+\$103,500+\$101,750+\$100,000\\ & =& \$410,500\end{array}$

Based on probability-weighted estimate, the total transaction price is $410,500.