QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
Part (a) Provide all journal entries required to correctly measure the
Marks
inventory of Zedex printers as at 31 December 2016
Dr Cr
R R
1. Right of return asset (SFP) (calculation 2) 17 897 1
Inventories (SFP) (calculation 1) 1 184 550
Cost of sales (P/L) (balancing amount) 771 803
Salaries (P/L) 300 000
1
Depreciation (P/L) 320 000
Fixed overheads (P/L) 781 250
Variable manufacturing overheads (P/L) 573 000
Correcting journal entry to account for
incorrectly expensed costs at year-end
2. Cost of sales (P/L) 128 000
1
Fixed overheads (P/L) 128 000
Reallocation of excess overheads
3. Cost of sales (P/L) (calculation 3) 434 550
1
Inventories (SFP) 434 550
Write down to net realisable value
Calculations R
1. Costs incorrectly expensed to be capitalised
Salaries: Manufacturing staff 300 000 1
-1 if
Salaries: Administrative staff - included
Depreciation: Manufacturing plant and equipment 320 000 1
Interest expense on specific loan financing purchase of raw -1 if
- included
materials
-1 if
Storage costs - included
Other fixed overheads – normal capacity 781 250 1
Other fixed overheads – excess over normal capacity -
Variable overheads 573 000 1
Total costs incorrectly expensed 1 974 250
Less: Printers sold 30 December 2016 (1 974 250 / 25 x 10) (789 700) 1C
Total costs to be capitalised (1 974 250 / 25 x 15) 1 184 550
2. Right of return asset to be corrected
[(1 974 250 / 25) + 100 000 raw material per printer] x 10 x 1% 17 897 1C
3. Write down to net realisable value
Cost of inventories on hand
Costs capitalised (calculation 1) 1 184 550
Raw materials (100 000 x 15) 1 500 000
or [(1 974 250 / 25) + 100 000)] x 15 2 684 550 1C
Net realisable value (R150 000 x 15) 2 250 000 1
Write down to net realisable value 434 550
Available 12
Maximum 12
Total for part (a) 12
Part (b) Write a memorandum to the Financial Director of PrintCo in
which you advise her how she should recognise and measure
Marks
the revenue transaction with AfricaQuest for the year ended 31
December 2016 in terms of IFRS 15 Revenue from Contracts with
1 © SAICA 2017
QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
Customers.
MEMORANDUM
To: Ms Director
From: A Student
Subject: Revenue matters
Date: xxx
This memo prescribes the correct recognition and measurement of the revenue
earned from the transaction with AfricaQuest in terms of IFRS 15: Revenue from
Contracts with Customers. The following five steps will be considered in
addressing the recognition and measurement requirements of IFRS 15:
1. Identify the contract with the customers
2. Identify the performance obligations
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations
5. Recognise revenue as the performance obligations are satisfied
(i) Identify the contract with the customer Max 2
Avail 6
1. AfricaQuest is a customer of PrintCo as it has contracted with PrintCo
to purchase ten Zedex printer bundles, which are an output of PrintCo’s 1
ordinary activities in exchange for a consideration.
2. PrintCo and AfricaQuest have approved the contract since it is in
accordance with the parties’ customary business practice that has been
1
established historically, and both parties are committed to perform their
respective obligations.
3. Both PrintCo and AfricaQuest’s rights regarding the printers to be
transferred can be identified – AfricaQuest has the right to receive 10
1
printers at a discount of 10% and PrintCo has the right to receive payment
upon transfer of the printers.
4. The payment terms for the printers to be transferred can be identified –
AfricaQuest paid 30% of the contract price on 30 December 2016 and the 1
remaining 70% is payable within 30 days from that date.
5. The contract has commercial substance since PrintCo’s cash flows will
1
change as a result of the contract.
6. It is probable that PrintCo will collect the consideration to which it is
entitled in exchange for the transfer of the printers since AfricaQuest has
already paid 30% of the total consideration and it is expected that 1
AfricaQuest has the intention and ability to pay the remainder of the
consideration as there is no indication that collection would not be probable.
(ii) Identify the performance obligations Max 7
Avail 10
1. At contract inception, PrintCo must assess the goods and services
promised to AfricaQuest, and identify a separate performance obligation
for each promise to transfer:
1
a good or service (or a bundle of goods or services) that is distinct; or
a series of distinct goods and services that are substantially the same
and that have the same pattern of transfer to the customer.
2. A good or service that is promised to a customer is distinct if both of the
following criteria are met:
the customer can benefit from the good or service either on its
own or together with other resources that are readily available to
1
the customer (i.e. the good or service is capable of being distinct);
the entity’s promise to transfer the good or service to the customer
is separately identifiable from other promises in the contract (i.e. the
good or service is distinct within the context of the contract).
2 © SAICA 2017
QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
3. Printer (separate)
3.1 The printer is capable of being distinct because the customer can
benefit from its use on its own without the two-year service and 1
maintenance warranty.
3.2 Furthermore, PrintCo’s promise to transfer the printer is separately
identifiable from other promises in the contract (i.e. distinct within the
context of the contract) since the printer is not highly dependent on, or
highly interrelated with, other goods or services promised in the
contract / the printer does not significantly modify or customise other 1
goods or services promised in the contract / PrintCo does not provide a
significant service of integrating the printer with other goods or services
promised in the contract (the printer is not used as an input to deliver a
combined output).
3.3 The printer is therefore a distinct good, and hence a separate performance
obligation.
4. 30-day money-back guarantee (not separate from printer)
4.1 This guarantee is not a separate performance obligation since, in
terms of IFRS 15, a promise to stand ready to accept a returned product is
1
not accounted for as a performance obligation in addition to the obligation
to provide a refund.
4.2 When PrintCo sold the printers with the 30-day money-back guarantee,
PrintCo has, in effect, made an uncertain number of sales. Only after the
1
return right expires will PrintCo know with certainty how many sales have
actually been made.
5. One year assurance warranty (not separate from printer)
Alternative 1 (IFRS15.B28 - .B33)
5.1 This warranty provides the customer with the assurance that the product
1
will function as intended for one year.
In other words, the customer does not receive a separate service as the
warranty only protects the customer from the product defects that were
present at the time of sale. Any subsequent replacements to remedy those
defects are merely costs of providing the product and would relate to
PrintCo’s past performance.
5.2 Furthermore, the warranty is not normally sold separately from the
1
printer.
5.3 The one-year assurance warranty is therefore not a separate performance
obligation and should be accounted for in accordance with IAS 37.
Alternative 2 (IFRS15.27 - .29)
5.1 The one-year assurance warranty is capable of being distinct since the
customer can benefit from it together with the printer that has already 1
been provided by PrintCo.
5.2 However, this warranty is highly dependent on and highly interrelated
with the printer since the customer cannot choose to buy the one-year
assurance warranty without buying the printer. PrintCo’s promise to 1
provide the one-year assurance warranty is therefore not separately
identifiable (ie. distinct within the context of the contract).
5.3 The one-year assurance warranty is therefore not a distinct service, and
hence not a separate performance obligation.
6. Two-year service warranty (separate)
Alternative 1 (IFRS15.B28 - .B33)
6.1 This warranty provides the customer with a service that is over and
above the mere provision of an assurance that the printer was sold in 1
the condition specified/inferred in the contract.
6.2 Furthermore, the warranty is normally negotiated separately with 1
3 © SAICA 2017
QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
customers (sold separately from the printer).
6.3 The two-year service warranty is therefore a distinct service, and hence a
separate performance obligation.
Alternative 2 (IFRS15.27 - .29)
6.1 The two-year service warranty is capable of being distinct since the
customer can benefit from it together with the printer that has already 1
been provided by PrintCo.
6.2 Since the warranty is normally negotiated separately with customers
(sold separately from the printer), it is not highly dependent on or highly
1
interrelated with other promises in the contract. Therefore the warranty
is separately identifiable from other promises in the contract.
6.3 The two-year service warranty is therefore a distinct service, and hence a
separate performance obligation.
7. Conclusion
7.1 There are therefore only two separate performance obligations in the
contract, namely the transfer of the printer and the transfer of the service
warranty.
(iii) Determine the transaction price Max 7
Avail 14
1. The transaction price is the amount of consideration to which an entity
expects to be entitled in exchange for transferring promised goods or 1
services to a customer.
2. The printers were sold to AfricaQuest at a 10% discount on the normal
selling price. Since PrintCo is not entitled to this amount, the 10%
1
discount should not be included in the transaction price (ie. R280 000
x 10 x 10% = R280 000 should not be included in the transaction price).
3. The consideration to which PrintCo expects to be entitled in its contract
with AfricaQuest is variable because it is contingent on the occurrence or 1
non-occurrence of a future event, being the possibility that the goods
will be returned within 30 days. 1
4. As such, PrintCo will need to estimate the amount of consideration to
which it will be entitled, using either the ‘expected value’ or ‘most 1
likely amount’.
5. Furthermore, the variable consideration must be allocated to the
entire contract (par. 84) because should the customer exercise its right to
1
return the printer, it will also, in effect, be surrendering its right to the two-
year warranty.
6. In this instance, the expected value of the variable consideration is
99% of the promised consideration since, based on historic data, 1% of 1
total sales are expected to fail.
7. PrintCo must, however, only include in the transaction price the variable
consideration estimated to the extent that it is highly probable that a
1
significant reversal of revenue recognised will not occur up until the
date when the right of return lapses.
8. Even though the right of return is outside of the control of PrintCo, the
historic data of five years provides evidence that the estimation of a mere
1% returns is reliable. It is therefore highly probable that a reversal of the 1
99% of revenue will not occur. This is further reinforced by the short period
of uncertainty (30 days).
9. The transaction price will therefore be R2 494 800 (R252 000 x 99% x 10
1C
printers).
10. The difference between the transaction price of R2 494 800 and the
4 © SAICA 2017
QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
amount received (and receivable) of R2 520 000 (R252 000 x 10 printers),
represents the sales that are expected to fail and must be refunded 1C
(R25 200). This amount should consequently be recognised as a refund
liability. 1
11. AfricaQuest paid 30% of the consideration immediately and the remaining
70% is payable within 30 days. Due to the short period of time between
when PrintCo transferred the printers and when AfricaQuest paid for the
printers, there is no significant financing component in respect of the
1
printers. This is also in line with the practical expedient which states that
the promised consideration need not be adjusted for a significant financing
component if the period between the transfer of the goods or services and
the payment for those goods or services is one year or less.
12. However, since the payment for the two-year service plan is upfront while
the related service will only be rendered over a two-year period, it should
be considered whether a significant financing component exists in respect
of the two-year service plan. It can, however, be argued that the timing of
1
the transfer of the goods and services under the two-year service plan is at
the discretion of the AfricaQuest (the customer) and therefore there will be
no significant financing component in respect of the two-year service
plan.
(iv) Allocate the transaction price to the performance obligations Max 5
Avail 7
1. PrintCo must allocate the transaction price to each of the performance
obligations in an amount that represents the consideration to which
1
PrintCo would expect to be entitled in exchange for both the printer and
the two-year warranty.
2. The transaction price must therefore be allocated to the two
performance obligations identified based on their relative stand-alone
1
selling prices, which is the price at which an entity would sell the
promised good or service separately to a customer.
3. The relative stand-alone selling price of the printer and the two-year
1P
warranty are R280 000 and R65 000 respectively.
4. Since the sum of the stand-alone selling prices of R3 450 000
((R280 000 + R65 000) = R345 000 x 10) exceeds the consideration
receivable under the contract of R2 520 000 (R280 000 x 90% x 10), 1
AfricaQuest received a discount for the purchase of the bundle of goods
and services. Since there is no observable evidence that the entire
discount relates to only one of the performance obligations in the contract, 1
the discount should be allocated proportionately to all the
performance obligations in the contract.
5. The transaction price of R249 480 per item must therefore be allocated
as follows:
5.1 Printer (R249 480 x R280/R345) = R202 477 x 10 = R2 024 770 1C
5.2 Two-year warranty (R249 480 x R65/R345) = R47 003 x 10 = R470 030 1C
(v) Recognise revenue as the performance obligations are satisfied Max 5
Avail 8
1. Revenue should be recognised when (or as) PrintCo satisfies the
performance obligations by transferring the promised goods and
services (i.e. the assets) to AfricaQuest. PrintCo should consider at the
1
inception of the contract whether each performance obligation will be
satisfied over time, or at a point in time. If a performance obligation is
not satisfied over time, it will be satisfied at a point in time.
5 © SAICA 2017
QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
2. The assets are transferred when (or as) AfricaQuest obtains control
of the assets. Control passes when the customer has the ability to direct
1
the use of, and obtain substantially all of the remaining benefits from the
asset or to restrict the access of other entities to those benefits.
3. Performance obligation: Transfer of printers
3.1 AfricaQuest obtained control of the printers when it took delivery of
the assets (30 December 2016). From this date, the customer has the
ability to direct the use of the assets and to substantially obtain all of the
remaining benefits from them.
1
The performance obligation in respect of the transfer of printers is
satisfied at a point in time since AfricaQuest does not simultaneously
receive and consume the benefits provided by PrintCo when the printers
are transferred.
3.2 The right to return the assets and to be refunded does not preclude the
assets from being controlled by the customer; instead it is an additional 1
confirmation of the ability of the customer to direct their use.
3.3 Revenue of R2 024 770 should therefore be recognised on 30 December
1
2016 for the sale of the printers.
4. Performance obligation: Transfer of two-year warranty
4.1 In this instance, the performance obligation in respect of the two-year
warranty is satisfied over time since AfricaQuest simultaneously receives
1
and consumes the benefits provided by the warranty (by PrintCo
performing the maintenance services and replacing malfunctioning parts).
4.2 Consequently no revenue should be recognised in respect of the two-
year warranty for the year ended 31 December 2016, as no time had yet 1
passed. (Alternatively, it can be argued that revenue should be recognised
for 1/730 days, since the date of the transaction was 30 December 2016).
Instead, the transaction price relating to this performance obligation 1
should be recognised as a liability (deferred income).
4.3 Subsequently, however, an appropriate method for measuring the entity’s
progress towards complete satisfaction of the performance obligation must
be selected. (Detail on appropriate method is not necessary as this
information relates to the recognition of revenue beyond December 2016.
This was not asked in the question.)
Available 45
Maximum 26
Communication skills – layout and structure 1
Communication skills – clarity of expression 1
Total for part (b) 28
6 © SAICA 2017
QUESTION 1 ITC JUNE 2017
PAPER 1 SUGGESTED SOLUTION
Part (c) Prepare the journal entries to account for the contract entered
into with NewsCo for the financial year ended 31 December 2016.
Assume that the practical expedients in terms of IFRS 15 parr. Marks
94 and 121 have not been used.
Ignore closing journal entries.
Dr Cr
R R
1. Bank (SFP) (3 x 3 000 000 payments) 9 000 000 1
NewsCo contract payable (SFP) 1 116 250 1C
Revenue (P/L) (calculation below) 7 883 750 1
Recognise the revenue from contract with
NewsCo for the period up to 31 December
2. Contract costs amortised (P/L)
(1 800 000 x 3/7) 771 429 1
or (1 800 000 x 35%) = 630 000
Contract costs / asset (SFP) 1 028 571
1C
Bank (SFP) 1 800 000
Recognition of costs to obtain contract and
amortising over the period till expected
completion
3. Contract expenses (P/L) 4 620 000
Bank / Creditors / Work in progress (SFP) 4 620 000 1
((15 000 000 – 1 800 000) x 35%)
Recognition of contract expenses incurred
up to date
4. No impairments recognised as there is no
receivable at reporting date
Calculation: Transaction price and revenue recognised R
Basic payment 21 000 000 1
Bonus – constrained (As being the first project of this kind and
therefore PrintCo lacks historical data to accurately model whether -
it would be highly likely that this revenue would not be reversed.)
Additional payments: Print usage
[(10% x 0) + (35% x 1 000 000) + (40% x 2 000 000) 1 525 000 1
+ (15% x 2 500 000)]
Total transaction price 22 525 000 1C
Revenue is recognised over time because PrintCo’s performances
creates and asset that NewsCo controls through the construction
period as the printing press is constructed on NewsCo’s premises
in Wynberg. An output based method was used to assess the
stage of completion, being the completion assessment conducted
by the independent technical engineer as at 31 December 2016 of
35%
Revenue recognised (total 35%) 7 883 750 1C
Available 10
Maximum 9
Communication skills – presentation 1
Total for part (c) 10
7 © SAICA 2017