@jc861 When service contracts are sold evenly throughout the year and the services are provided evenly through out the year you can use the mid-month approach. Its not the only way to estimate average revenue, but that's what they are using here.
Let's look at December. Contracts sold on Dec 1 will incur 31 days of service under contract as of the year end. Contracts sold on Dec 2 will get 30 days of service, etc. Likewise, contracts sold on Dec 31 will only incur 1 day of service. On average, contracts sold in Dec will incur approx 15-16 days of service, right? Another way of saying this is that Dec 15th is the average sale date. So you could say contracts sold in Dec get .5 months worth of service on average. For the year ending Dec 31, Dec contracts can recognize an average of .5 months of service contract revenue earned.
November, however, those contracts will incur an average of .5 months of service in the month of November plus a whole month of service in December. For the year ending Dec 31, November contracts can recognize an average of 1.5 months of service contract revenue earned.
If you continue the pattern, October contracts get 2.5 months service, September contracts get 3.5 months, etc. If you add it all up, you get .5+1.5+2.5+3.5+4.5+5.5+6.5+7.5+8.5+9.5+10.5+11.5=72 and divide by 12 months to get the average for the year 72/12 = 6. For the year, you will recognize an average of 6 months of service. Another way of saying this is that July is the average month of sale.
This is the mid month rule. When contracts are sold evenly and the work is performed evenly, you can go ahead and assume the annual service revenue recognized is half. They use the same kind of logic in tax for the mid-month convention for depreciation. Its just an estimating technique.
40% of contract services are preformed in the first year, so
600k * .4 = 240k earned during first 12 months of contract sold
average of 6 months worth of service is recognized per the mid-month rule
240k * 6/12 = 120k recognized as of Dec 31
600k – 120k = 480k unrecognized as of Dec 31
Using your calculations, you can actually get the right answer this way. There's going to be small differences between the way you estimated averages and the way Becker estimates averages.
You got 600k – 129k = 471k unrecognized, so 480k is a pretty close answer. None of the others are close.
If it makes you feel any better, this is a weird ass question. Most of the actual exam questions are not like this. This question tests revenue recognition, which is covered in the material, but it also tests the mid-month method of averaging, which is obscure and not in the material. I think it might be in the test bank just to throw you off your game.
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