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Sir,
I got this adjustment from an published accounts sum,D’s.co. profit or loss includes $7.8 million of revenue for credit sales made in March. Dexon applied a mark-up on cost of 30% on all sales. In April the auditors stated that the contract does not have commercial substance and revenue should not be recognised for this contract.
My question is
1.When is the contract considered to have commercial substance?
2. And as per the solution $6000 was added back to cost of sales? I want to know why it is done so?Thank you in advance
Looking forward for your answer1) When it’s a genuine sale. In the case of Dexon, the directors are (apparently) trying to manipulate the figures to show a better profit figure than has actually been achieved. It could alternatively be the case that they wish to show a lower level of inventory so they have “manufactured” some sales and will probably have negotiated with the customer that Dexon will repurchase those goods shortly after the year end
2) What we need to do is to reverse the non-commercial transaction
So:
Dr Revenue $7.8 million
Cr Receivables $7.8 millionand that takes the goods out of revenue and out of current assets
But now we need to bring those goods back into inventory, so find the cost of those sales 100/130 x $7.8 million = $6 million, and:
Dr Closing inventory, current asset on the statement of financial position $6 million
Cr Closing inventory, reduce cost of sales on the statement of profit or loss $6 millionor, put more simply:
Dr Asset on the statement of financial position $6
Cr Cost of sales on statement of profit or loss $6(and I don’t think that $6 million has been added back in the solution! I imaging that it has been deducted from the figure given in the question)
OK?
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