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Thanks for taking the time to look at this!
Exam question sandown 2009:
Sandown’s revenue includes $16 million for goods sold to Pending on 1 October 2008. The terms of the sale are that Sandown will incur ongoing service and support costs of $1.2 million per annum for three years after the sale. Sandown normally make a gross profit of 40% on such servicing and support work.
Answer given in answers 2009:
IAS 18 Revenue requires that where sales revenue includes an amount for after sales servicing and support costs then a proportion of the revenue should be deferred. The amount deferred should cover the cost and a reasonable profit (in this case a gross profit of 40%) on the services. As the servicing and support is for three years and the date of the sale was 1 October 2008, revenue relating to two year’s servicing and support provision must be deffered: ($1.2 million x 2/0.6) = $4 million. This is shown as $2 million in both current and non-current liabilities.I don’t get it – why do you divide 2 by 0.6????
In the BPP text book their example is:
A product is sold with 1 year’s after sales support, the cost of providing support to one customer for a year is calculated to be $50. The company has a mark-up on cost of 15%, the product is sold for $350, how is the sale accounted for?
Answer
$292.50 as revenue
$57.50 as deferred income and recognised over the course of the yeari can’t understand why the answer booklet has 2/0.6…..
someone explained one is a mark-up the other a gross profit margin – that explains different treatment but to me that still doesn’t make any sense – why divide 2 by 0.6?? I could understand if you multiplied 1.2 by 0.6 to remove the profit margin of 40% – but why would you divide the number of years by 0.6?
also in Bpp book it says:
servicing fees included in the price
the sales price of a product may include an identifiable amount for subsequent servicing. in this case, that amount is deferred and recognised as revenue over the period during which the service is performed. The amount deferred must cover the cost of those services with a reasonable profit on those services.So why remove the profit margin at all or multiply the figure by a % or fraction (0.6)? Is the text in the BPP a recent revision to IAS 18 revenue and the exam question old rules?
Hi
It’s not 2 years which are being divided by .6!
Cost + profit = selling price
here we are told that the gross profit margin is 40%
So, in the basic equation, ? + 40% = 100%
Therefore, the cost element of the service is 60%.
And cost is, we are told, $1.2. Now, if 1.2 is 60%, how much is 100%?
Answer, divide the cost of 1.2 by .6 and you arrive at the figure for 100%.
Now, in the question, we need to do this twice – for each therefore of two years.
Thus, we arrive at the calculation “1.2 * 2 / .6”
This could be better written as “(1.2 / .6) *2 years”
Does that help?
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Dear Mike,
In this question of Sandown, why the cost of 1.2*2 is not deducted from cost of sales when its matching revenue has been deducted from sales revenue?
One of my study buddy guesses as it’s service rather than goods.
Looking forward to your reply. Thanks!
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Hello Mike,
Would you please have a look at my question (above this post). Thank you!
Hi, again I do not have access to the question but, from memory ….
This is a service business and has no real “cost of sales” as in “production costs” What we ARE able to do is allocate correctly the revenue under matching principles to the years which will benefit from that revenue. I believe that the cost of providing the on-going service for two years is not included within the existing cost of sales figures. That’s really the reason why we are deferring the revenue – to match it with the costs which we know ARE going to be incurred when we provide the service over the next two years
OK?
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