On April 2, 2021, Pharma Company entered into a contract to supply medication to Laxall Drug Stores, FOB shipping point, terms 2/30, n/45. The selling price of the medication is $40,000 and the medication cost Pharma Company $25,000. Pharma has a stated return policy that goods may be returned within 30 days. The medication was shipped on April 10, 2021. Pharma’s management estimates returns using the expected value method and sales discounts are estimated using the most likely outcome. Based on past experience with this product, returns are 5% of sales 50% of the time, 10% of sales 20% of the time, and 20% of sales 30% of the time. Laxall Drug Stores will most likely pay within the discount period. Pharma Company uses the contract-based approach for revenue recognition.

Instructions

a. Describe the rights and obligations of each party in the contract between Pharma Company and Laxall Drug Stores.

b. Identify the variable consideration in the contract.

c. Calculate the transaction price. (Round all amounts to the nearest dollar.)

d. Prepare journal entries to recognize revenue on the appropriate date. (Hint: The expected value method is also used to determine the amount for cost of goods sold and estimated inventory returns.)

Taking It Further

Assume Laxall Drug Stores returns 5% of the medication purchased within the return period. Will this aff ect the amount of revenue that Pharma Company recognizes? Explain.