Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AA Exams › Darjeeling Co-servicing cost & upfront payment
- This topic has 7 replies, 2 voices, and was last updated 4 years ago by Kim Smith.
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- July 15, 2019 at 11:01 am #523548
Good day, Sir
The question is like this,
Darjeeling Co purchased and installed a new manufacturing line.
The costs include purchase price $2.2m, installation cost $0.4m and five years servicing and maintenance $0.5m.Is the upfront payment for the 5 years servicing cost?
Why the Profit will be overstated instead of understated?
Also why does the prepayment will be understated?July 15, 2019 at 11:08 am #523551The $0.5m is revenue expense – not capital. Profit will be overstated because there s/be $0.1m servicing/maintenance expense in profit and loss.
Asset is overstated $0.5m (less attributable depreciation) in SoFP and prepayment understated (by $0.4m).
July 15, 2019 at 3:39 pm #523652Sorry Sir, I still not got it.
I’m only understand that the $0.5m is revenue expense in nature.
But not so understand why the profit will be overstated, not only when the expenses are less?
In addition, what cause the prepayment understated and how it is understated?
Not so understated the theory in here?July 15, 2019 at 5:09 pm #523679Profit = Revenue (A) – expenses (B)
If B is understated (e.g. because a cost has been capitalised in SoFP instead of expensed in SoPL), profit must be overstated. (Profit could also be overstated if A is overstated.)$0.5m paid for 5 years is $0.1m expense in current year and £0.4m prepaid in respect of the next 4 years’ expense.
I suggest you download the FA notes (assumed knowledge for AA) for reference.
July 15, 2019 at 6:05 pm #523706The prepayment is understated is it simply because of the $0.5m being wrongfully capitalised as IAS 16 instead to the prepayment itself?
Am I right, Sir?
July 15, 2019 at 6:25 pm #523709Yes
July 15, 2019 at 6:48 pm #523713Thank you Sir for your help. Have a nice day.
July 16, 2019 at 6:00 am #523761You are welcome!
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