Question

Tyler Financial Services performs bookkeeping and tax-reporting services to startup companies in the Oconomowoc area. On January 1, 2017, Tyler entered into a 3-year service contract with Walleye Tech. Walleye promises to pay $10,000atthebeginningofeachyear,whichatcontractinceptionisthestandalonesellingpricefortheseservices.Attheendofthesecondyear,thecontractismodifiedandthefeeforthethirdyearofservicesisreducedto$8,000. In addition, Walleye agrees to pay an additional $20,000 at the beginning of the third year to cover the contract for 3 additional years (i.e., 4 years remain after the modification). The extended contract services are similar to those provided in the first 2 years of the contract.

Instructions

(a) Prepare the journal entries for Tyler in 2017 and 2018 related to this service contract.

(b) Prepare the journal entries for Tyler in 2019 related to the modified service contract, assuming a prospective approach.

(c) Repeat the requirements for part (b), assuming Tyler and Walleye agree on a revised set of services (fewer bookkeeping services but more tax services) in the extended contract period and the modification results in a separate performance obligation.

Short answer

Service revenue for 3^rd year is $7,000.

Step-by-step solution

Meaning of Contract Modification

A contract modification refers to the contract in which one or more areas are altered that brings new elements into the specifics or cancels some of them while keeping the contract's overall purpose and impact intact.

Journal entries for Tyler in 2019

Date	Particular	Debit ($)	Credit ($)
January 1, 2019	Cash a/c	28,000
	Unearned revenue a/c		28,000
December 31, 2019	Unearned revenue a/c	7,000
	Service revenue a/c		7,000

Working Notes:

$\begin{array}{rcl}\mathrm{Unearned}\mathrm{revenue}& =& \mathrm{Amount}\mathrm{paid}\mathrm{in}\mathrm{beginning}\mathrm{of}3\mathrm{rd}\mathrm{year}+\mathrm{Fee}\mathrm{for}3\mathrm{rd}\mathrm{year}\mathrm{after}\mathrm{modification}\\ & =& \$20,000+\$8,000\\ & =& \$28,000\\ \mathrm{Service}\mathrm{revenue}\mathrm{for}3\mathrm{rd}\mathrm{year}& =& \frac{\mathrm{Unearned}\mathrm{revenue}}{4\mathrm{years}}\\ & =& \frac{\$28,000}{4}\\ & =& \$7,000\end{array}$