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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?The $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).
Sorry 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?Profit = 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.
The 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?
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