- 20 Marks
Question
Dango Plc is a conglomerate company operating in Nigeria with diverse interests across Africa. It prepares its financial statements in accordance with International Financial Reporting Standards with a year-end of September 30. The following transactions relate to Dango Plc.
(a) In February 2016, Dango Plc won a significant new contract to supply large quantities of rice to the government of Guyama, a small West African country, for the next two years. Under the terms of the arrangement, payment is made in cash on delivery once goods have been cleared by customs. The rice will be delivered in batches four (4) times every year, on April 1, July 1, October 1, and January 1. The batches for April 1, 2016, and July 1, 2016, amounting to N250 million and N380 million respectively, were delivered and paid. Dango incurred significant costs on customs duties for the first batch of delivery. The October 1 batch, valued at N520 million, was shipped prior to the year-end but delivered and paid for on October 1, 2016.
(b) On October 1, 2010, a 12-year licence was awarded to Dango Plc by the Federal Government to be the sole manufacturer of a chemical used in the Nigerian pharmaceutical industry. The licence was recognised on that date at its fair value of N196 million. The award of the licence motivated Dango Plc in 2011 to purchase a division of another Nigerian competitor company making similar products. Goodwill of N240 million was recognised on the purchase of the division. Dango Plc merged the activities of the newly acquired division with its own to create a specialist chemical sub-division, which it now classifies as a separate cash-generating unit. By 2016, the revenue of this cash-generating unit now amounts to 5% of the Group’s revenue.
(c) Dango Plc buys raw materials from overseas suppliers. It has recently taken delivery of 1,000 units of component X, used in the production of chemicals. The quoted price of component X was N1,200 per unit, but Dango Plc has negotiated a trade discount of 5% due to the size of the order. The supplier offers an early settlement discount of 2% for payment within 30 days, and Dango Plc intends to achieve this. Import duties of N60 per unit must be paid before the goods are released through customs. Once the goods are released, Dango Plc must pay a delivery cost of N5,000 to have the components taken to its warehouse.
Required:
Write a report to the directors advising them on the correct accounting treatment of the above transactions in the financial statements for the year ended September 30, 2016, in accordance with the provisions of the relevant standards.
Note: You may consider the relevance of the following standards to the transactions: IAS 20, IAS 2, IAS 38, IFRS 3, and IFRS 15.
Answer
From: Mr. ABC
To: The Directors, Dango Plc
Date: May 16, 2017
Subject: Relevant Accounting Treatments of Transactions
The purpose of this report is to explain the relevant accounting treatments for the transactions mentioned in accordance with the applicable accounting standards and International Financial Reporting Standards (IFRS) such as IAS 20, IAS 38, IFRS 3, and IFRS 15. The explanations are as follows:
(a) Revenue Recognition
In accordance with IFRS 15: Revenue from Contracts with Customers, the core principle is delivered in a five-step model framework:
- IFRS 15 requires revenue to be recognized when (or as) the performance obligation is satisfied.
- The performance obligation is satisfied when an entity transfers a promised good or service to a customer.
- A good or service is considered transferred when the customer obtains control of the asset (i.e. the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset).
- To determine when a customer obtains control of a promised asset and when an entity satisfies the performance obligation, the entity must consider indicators of the transfer of control.
- Indicators of transfer will include the customer having the significant risks and rewards of ownership of the asset and the customer accepting the asset.
Applying the above principles to Dango Plc’s case, the performance obligation and transfer of control will be deemed to have occurred when the rice is delivered to the government of Guyama, as this is when the customer assumes the risks and rewards of ownership and accepts the goods.
Therefore, for the year ended September 30, 2016, revenue should be recognized for the April 1, 2016 (N250 million) and July 1, 2016 (N380 million) deliveries, totaling N630 million.
Based on this, revenue will not be recognized for the October 1, 2016 delivery, as it occurs after the year-end.
The significant customs duties incurred by Dango for the first batch should be expensed in line with the matching concept. Costs incurred for the October 1, 2016, delivery should be held as work in progress in the statement of financial position until the revenue is recognized in the year ended September 30, 2017.
(b) Licence and Goodwill
In compliance with IAS 38: Intangible Assets, the license awarded to Dango Plc by the Federal Government on October 1, 2010, should be recognized at its fair value of N196 million. This license should then be amortized over its useful life of 12 years, starting from the award date.
The goodwill of N240 million created during the business combination (purchase of the division) should be recognized in the financial statements in accordance with IFRS 3: Business Combinations. Goodwill represents the excess of the purchase consideration over the fair value of the acquired identifiable net assets. Once recognized, goodwill is not amortized, but it must undergo an annual impairment review.
Furthermore, according to IAS 38, all internally generated goodwill should not be recognized in the financial statements.
A cash-generating unit (CGU), as defined by IAS 38, is the smallest identifiable unit that generates independent cash flows. There is no minimum revenue threshold required for classifying a unit as a CGU.
(c) Valuation of Inventory as at September 30, 2016
According to IAS 2: Inventories, inventory should be valued at the lower of cost and net realizable value. The cost of inventory includes the purchase price and all directly attributable costs incurred to bring the inventory to its current location and condition.
IAS 2 specifies that the cost of inventories includes all costs of purchase, conversion costs, and other costs incurred in bringing inventories to their present location and condition.
Calculation of Cost of Inventory:
| Item | Amount (N) |
|---|---|
| Purchase price (1,000 units x N1,200) | 1,200,000 |
| Less trade discount (5% x N1,200,000) | (60,000) |
| Net purchase price | 1,140,000 |
| Import duties (N60 x 1,000 units) | 60,000 |
| Delivery costs | 5,000 |
| Total cost | 1,205,000 |
Note: The purchase price excludes any settlement discounts and is based on the cost after deduction of the trade discount. This means that the purchase cost of inventory includes the deduction of trade discounts, but settlement discounts are not considered when valuing the inventory. The 2% early settlement discount should be recognized as income in the statement of profit or loss, not as part of inventory valuation.
Conclusion
The provisions of IFRS regarding the correct treatment of revenue recognition for contracts with customers, the recognition of internally generated goodwill, and the valuation of inventory have been addressed in this report. Dango Plc. should apply these guidelines in the preparation of its financial statements for the year ended September 30, 2016.
- Tags: Accounting Standards, Customs Duties, Discounts, Goodwill, Licenses, Revenue
- Level: Level 3
- Uploader: Kofi