Question

Nair Corp. enters into a contract with a customer to build an apartment building for \(1,000,000. The customer hopes to rent apartments at the beginning of the school year and provides a performance bonus of \)150,000 to be paid if the building is ready for rental beginning August 1, 2018. The bonus is reduced by $50,000 each week that completion is delayed. Nair commonly includes these completion bonuses in its contracts and, based on prior experience, estimates the following completion outcomes:

Completed by Probability

August 1, 2018 70%

August 8, 2018 20

August 15, 2018 5

After August 15, 2018 5

Determine the transaction price for this contract.

Short answer

Transaction pricefor this contract is $1,127,500.

Step-by-step solution

Meaning of Performance Bonus

Aperformance bonus is a sort of additional remuneration given to an individual or department as a reward for meeting established goals.

Transaction price of this contract

Apartment building cost (price of contract) = $1,000,000

Bonus by August 1, 2018 = $150,000

Probability by August 1, 2018 = 70%

$$\begin{gathered} \mathrm{Price}\mathrm{by}\mathrm{August}1,2018=\left(\mathrm{Price}\mathrm{of}\mathrm{contract}+\mathrm{Bonus}\right)\times \mathrm{Probability} \\ =\left(\$1,000,000\$150,000\right)\times 70\% \\ =\$1,150,000\times \frac{70}{100} \\ =\$805,000 \end{gathered}$$

Bonus by August 8, 2018 = $100,000

Probability by August 8, 2018 = 20%

role="math" localid="1648280899411" $$\begin{gathered} \mathrm{Price}\mathrm{by}\mathrm{August}8,2018=\left(\mathrm{Price}\mathrm{of}\mathrm{contarct}+\mathrm{Bonus}\right)\times \mathrm{Probability} \\ =\left(\$1,000,000+\$100,000\right)\times 20\% \\ =\$1,100,000\times \frac{20}{100} \\ =\$220,000 \end{gathered}$$

Bonus by August 15, 2018 = $50,000

Probability by August 15, 2018 = 5%

$$\begin{gathered} \mathrm{Price}\mathrm{by}\mathrm{August}15,2018=\left(\mathrm{Price}\mathrm{of}\mathrm{contract}+\mathrm{Bonus}\right)\times \mathrm{Probability} \\ =\left(\$1,000,000+\$50,000\right)\times 5\% \\ =\$1,050,000\times \frac{5}{100} \\ =\$52,500 \end{gathered}$$

Bonus after August 15, 2018 = $0

Probability after August 15, 2018 = 5%

$$\begin{gathered} \mathrm{Price}\mathrm{after}\mathrm{August}15,2018=\left(\mathrm{Price}\mathrm{of}\mathrm{Contract}+\mathrm{Bonus}\right)\times \mathrm{Probability} \\ =\left(\$1,000,000+\$0\right)\times 5\% \\ =\$1,000,000\times \frac{5}{100} \\ =\$50,000 \end{gathered}$$

$$\begin{gathered} \mathrm{Transaction}\mathrm{Price}=\mathrm{Price}\mathrm{by}\mathrm{August}1+\mathrm{Price}\mathrm{by}\mathrm{August}8+\mathrm{Price}\mathrm{by}\mathrm{August}15+\mathrm{Price}\mathrm{after}\mathrm{August}15 \\ =\$805,000+\$220,000+\$52,500+\$50,000 \\ =\$1,127,500 \end{gathered}$$