Question

Topic-Research and Development Costs

Beta Ltd incurred development costs that may be capitalised of Sh.24,000,000 on 31 March 2014.The asset was available for use on 1 May 2014 and the marketing division completed the following estimates of future sales for the year ending 31st December:

2014	2,800,000(production commenced on 30 June 2014)
2015	3,600,000
2016	3,300,000
2017	2,000,000
2018	1,800,000 (production ceased and asset derecognised on 30 June 2018)

The average gross profit mark-up on sales is 25% , while the associated sales and administrative expenses amount to 6% of the selling price.The fair pre-tax discount rate for Beta Ltd is 10% and the cash flow are deemed to have taken place on the last day of the Financial year.The fair value less costs to sell of the asset is Sh.13,000,000 at 31st December 2016

The company plans to amortise the development costs over a period of 48 months ( the estimated market life) but a technical problem caused production to cease temporarily between 1 january 2016 and 31 May 2016.The total development costs were written off during the year ended 31 December 2015 as the technical feasibility of the product was questioned at that stage and thus an impairment loss was recognized.

Further development costs amounting to Sh.3,900,000 were incurred between January and May 2016.However, the problem with technical feasibility was solved in the interim and production recommenced on 1 june 2016, thus leading to a reversal of the impairment loss.The actual sales figure for 2016 was Sh.28,000,000, while the estimates for 2017 and thereafter increased by 20% as a result of an unexpected increase in demand for the now improved product.The estimated market life still expires on 30 june 2019

Required:

Illustrate how development costs will be accounted for in the statement of comprehensive income for the year ended 31 december 2015 (show your workings)

Answer 1

Asset will be capitalized at the lowest of the below:

1. Cost incurred - 24000000

2. Fair vaue less cost to sell - 13000000

3. Discounted value of future cash flow - 11052596(say 11052600)

Cash flow	Discount factor	Value
2800000	0.9535	2669695.25
3600000	0.8668	3120423.019
3300000	0.7880	2600352.516
2000000	0.7164	1432701.111
1800000	0.6830	1229424.22
Total value		11052596.12

So asset will be depreciated at 2763150(11052600/4) every year.

Revised Estimated:

1. Cost incurred - 27900000

2. Fair vaue less cost to sell - 13000000

3. Discounted value of future cash flow - 11191028(say 11191000)

Cash flow	Discount factor	Value
2800000	0.9535	2669695.25
3600000	0.8668	3120423.019
3300000	0.7880	2206359.711
2400000	0.7164	1719241.333
2160000	0.6830	1475309.064
Total value		11191028.38

So asset will be depreciated at 2797750(11191000/4) every year.