Question

Analyze why they have used this way to answer the below question (The question is already answered I need analysis for the answer like a paragraph for each case)

Example: On 1/2/08, See-Saw Systems (S3) purchased a patent valued at €8 million; it had a useful life of 8 years with zero residual value, and S3 used straight-line depreciation. On 1/2/10, the fair value of the patent had decreased to €4.5 million. On 1/2/12, the fair value had increased to €6 million, and on 1/2/14, the fair value had dropped to €1 million. Assuming S3 uses the revaluation model, determine how the gains and losses are reported.

Straight-line amortization is €8 million ÷ 8 years = €1 million per year, so the book value on 1/2/10 is:

€8 million − 2(€1 million) = €6 million

The revaluation to €4.5 million results in a €1.5 million loss, which appears on S3’s income statement.

Straight-line amortization is now €4.5 million ÷ 6 years = €750,000 per year. On 1/2/12 the book value is:

€4.5 million − 2(€750,000) = €3 million

The revaluation to €6 million results in a €3 million gain. Because S3 had a previous €1.5 million loss on its income statement, the first €1.5 million of the gain is shown on the income statement to reverse the loss; the remaining €1.5 million gain goes to the Revaluation Surplus account on S3’s balance sheet.

Straight-line amortization is now €6 million ÷ 4 years = €1.5 million per year.

On 1/2/14 the book value is:

€6 million − 2(€1.5 million) = €3 million

The revaluation to €1 million results in a €2 million loss. Because S3 had a previous €1.5 million gain in the Revaluation Surplus account in equity, the first €1.5 million of the loss reduces the Revaluation Surplus account to zero. The remaining €500,000 million loss is shown on S3’s income statement.

Answer 1

Patent purchased on 1/2/08 with a useful life of 8 years means valid till 1/2/16, with a residual value of zero. Its mentioned that S3 uses the straightline method of depreciation hence equal amounts would be amortized every year over the life of the patent (8 years). Its also mentioned that S3 uses revaluation model to amortize patents which as per the relevant accounting standard means that everytime that there is a change in the fair value of the patent the book value of it has to be brought to the fair value, if revaluation results in a loss it has to be expensed on the income statement and if it turns out to be a gain it should be posted to a revaluation surplus account.

Straight-line amortization is €8 million ÷ 8 years = €1 million per year, so the book value on 1/2/10 is:

€8 million − 2(€1 million) = €6 million

The revaluation to €4.5 million results in a €1.5 million loss because fair value as on 1/2/10 is €4.5 million whereas its book value on the same date is €6 million , which appears on S3’s income statement as loss on revaluation.

Straight-line amortization is now €4.5 million ÷ 6 years (balance remaining life)= €750,000 per year. On 1/2/12 the book value is: €4.5 million − 2(€750,000) = €3 million

The revaluation to €6 million results in a €3 million gain. Because S3 had a previous €1.5 million loss on its income statement, the first €1.5 million of the gain is shown on the income statement to reverse the loss; the remaining €1.5 million gain goes to the Revaluation Surplus account on S3’s balance sheet.

Straight-line amortization is now €6 million ÷ 4 years = €1.5 million per year.

On 1/2/14 the book value is: €6 million − 2(€1.5 million) = €3 million

The revaluation to €1 million results in a €2 million loss. Because S3 had a previous €1.5 million gain in the Revaluation Surplus account in equity, the first €1.5 million of the loss reduces the Revaluation Surplus account to zero. The remaining €500,000 million loss is shown on S3’s income statement.