Cash flows from capitalising development costs

Hello Sir,

Please clarify the following items of cash flows:

– Capitalising development costs -Do we have to add it or substract it in investing activities and why

– Gain from revaluation of property -in which cash flow it has to go .Do we have to deal with it like the gain of sale of assets

like the case in the following question

Thanks,

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Q
MOSTON Walk in the footsteps of a top tutor
The following trial balance extracts (i.e. it is not a complete trial balance) relate to Moston
as at 30 June 20X5:
$000 $000
Revenue 113,500
Cost of sales 88,500
Research and development costs (note (i)) 7,800
Distribution costs 2,800
Administrative expenses (note (iii)) 6,800
Loan note interest and dividends paid (notes (iii) and (v)) 5,000
Investment income 300
Equity shares of $1 each (note (v)) 30,000
5% loan note (note (iii)) 20,000
Retained earnings as at 1 July 20X4 6,200
Revaluation surplus as at 1 July 20X4 3,000
Other components of equity 9,300
Property at valuation 1 July 20X4 (note (ii)) 28,500
Plant and equipment at cost (note (ii)) 27,100
Accumulated depreciation plant and equipment 1 July 20X4 9,100
The following notes are relevant:
(i) Moston commenced a research and development project on 1 January 20X5. It spent
$1 million per month on research until 31 March 20X5, at which date the project
passed into the development stage. From this date it spent $1.6 million per month
until the year end (30 June 20X5), at which date development was completed.
However, it was not until 1 May 20X5 that the directors of Moston were confident that
the new product would be a commercial success.
Expensed research and development costs should be charged to cost of sales.
(ii) Non?current assets:
Moston’s property is carried at fair value which at 30 June 20X5 was $29 million. The
remaining life of the property at the beginning of the year (1 July 20X4) was 15 years.
Moston does not make an annual transfer to retained earnings in respect of the
revaluation surplus. Ignore deferred tax on the revaluation.
Plant and equipment is depreciated at 15% per annum using the reducing balance
method.
No depreciation has yet been charged on any non?current asset for the year ended 30
June 20X5. All depreciation is charged to cost of sales.
(iii) The 5% loan note wasissued on 1 July 20X4 at its nominal value of $20 million incurring
direct issue costs of $500,000 which have been charged to administrative expenses.
The loan note will be redeemed after three years at a premium which gives the loan
note an effective finance cost of 8% per annum. Annual interest was paid on 30 June
20X5.

(iv) A provision for current tax for the year ended 30 June 20X5 of $1.2 million is required,
together with an increase to the deferred tax provision to be charged to profit or loss
of $800,000.
(v) Moston paid a dividend of 20 cents per share on 30 March 20X5, which was followed
the day after by an issue of 10 million equity shares at their full market value of $1.70.
The share premium on the issue was recorded in other components of equity.
Required:
(a) Prepare the statement of profit or loss and other comprehensive income for Moston
for the year ended 30 June 20X5. (10 marks)
(b) Prepare the statement of changes in equity for Moston for the year ended 30 June
20X5. (5 marks)
(c) Prepare extracts from the statement of cash flows for Moston for the year ended 30
June 20X5 in respect of cash flows from investing and financing activities.
(5 marks)
Note: The statement of financial position and notes to the financial statements are NOT
required.
(Total: 20 marks)

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Anwer
(a) Moston – Statement of profit or loss and other comprehensive income for the year
ended 30 June 20X5
$000
Revenue 113,500
Cost of sales (W1) (97,700)
–––––––
Gross profit 15,800
Distribution costs (2,800)
Administrative expenses (6,800 – 500 loan note issue costs) (6,300)
Investment income 300
Finance costs (W2) (1,560)
–––––––
Profit before tax 5,440
Income tax expense (1,200 + 800) (2,000)
–––––––
Profit for the year 3,440
Other comprehensive income
Items that will not be reclassified to profit or loss
Gain on revaluation of property (29,000 – (28,500 – 1,900) (W1)) 2,400
–––––––
Total comprehensive income for the year 5,840
–––––––
(b) Moston – Statement of changes in equity for the year ended 30 June 20X5
Share
capital
Other
components
of equity
Revaluation
surplus
Retained
earnings
Total
equity
$000 $000 $000 $000 $000
Balance at 1 July 20X4 20,000 2,300 3,000 6,200 31,500
Share issue (W3) 10,000 7,000 17,000
Total comprehensive income for the year 2,400 3,440 5,840
Dividends paid (W3) (4,000) (4,000)
–––––– –––––– –––––– –––––– ––––––
Balance at 30 June 20X5 30,000 9,300 5,400 5,640 50,340
–––––– –––––– –––––– –––––– ––––––
(c) Moston – Statement of cash flows for the year ended 30 June 20X5
Cash flows from investing activities $000
Capitalised development costs (3,200)
Investment income 300
Cash flows from financing activities
Shares issued 17,000
Dividends paid (4,000)
Loan notes issued 19,500

Workings (monetary figures in brackets in $000)
(W1) Cost of sales
$000
Per trial balance 88,500
Depreciation of property (28,500/15 years) 1,900
Depreciation of plant and equipment
((27,100 – 9,100) × 15%) 2,700
Research and development expenses (see below) 4,600
––––––
97,700
––––––
Tutorial note
Development costs can only be capitalised from the date the directors became confident
that the new product would be commercially successful, which is 1 May. Research of $3
million (3 months at $1 million per month) from January to March and April’s costs of
$1.6 million should be expensed, a total of $4.6m. This leaves $3.2 million (2 months at
$1.6 million per month) to be capitalised at the year end.
(W2) Loan interest
$000
5% loan note ((20,000 – 500) × 8% see below) 1,560
––––––
The 5% loan note issue costs should not be charged to administrative expenses,
but deducted from the proceeds of the loan, leaving an initial value of $19.5m.
(W3) Dividend paid and share issue
Note that the dividend was paid prior to the share issue and is therefore
calculated based on 20 million shares (30 million – 10 million).
$000
Dividend paid 20 million × 20¢ 4,000
––––––
Share issue: 10 million × $1.70 = $17m, split $10m capital, $7m premium.