Question2 a On 1 July 2014 Cooper plc entered into a 5 milli

Question2 a) On 1 July 2014, Cooper plc entered into a £5 million contract for the supply of computer hardware and five years of after-sales support. The cost of providing after-sales support is estimated at £500,000 per annum and the mark-up on similar after-sales only contracts is 30% on cost (i.e. cost + 30% mark-up). On 1 September 2014, Cooper plc received the £5 million for this contract and recognised the full amount as revenue in its income statement for the year ended 31st December 2014. Explain why the revenue recognition approach adopted by Cooper plc is not appropriate Describe the correct revenue recognition approach and calculate the revenue that should be recognised in each accounting period until the end of the contract. 10 marks

Solution

As per matching principle of accounting to determine the income of an entity in an accounting period, the revenues and expenses should be matched for the period.

The revenue recognition approach by Cooper plc is not appropriate because , revenues should be recognised for delivering goods or services.

In this case revenue is recognized without completing revenue generation process and when revenue is not yet earned.

The after sales contract is for five years and Cooper plc will need to provide services for five years. Hence revenue recognition should be over five years and expenses will also be incurred for five years. In this case revenue is recognized without matching expenses.

Estimated revenue during the five years of after sales serice= (£ 500,000 *5)*1.3= £     3,250,000

Out of £   5,000,000 contract, the supply portion is (5000000-3250000)= £ 1,750,000

After sales service portion=£ 3,250,000

During 2014 , the supply portion is 100% completed

But the after sales service portion is completed 4 months out of total 60=(5*12) months

Percentage completed=4/60=0.066666667=6.6666667%

Hence revenue that should be recognized for After sales service=0.066666667*£ 3,250,000

Revenue that should be recognized for After sales service= £ 216,667

Total revenue that should be recognized in 2014=£ 216,667+£ 1,750,000= £ 1,966,667

Annual revenue from after sales service=3250000/5=£ 650,000

Total revenue that should be recognized in 2015=£ 650,000

Total revenue that should be recognized in 2016=£ 650,000

Total revenue that should be recognized in 2017=£ 650,000

Total revenue that should be recognized in 2018=£ 650,000

Total revenue that should be recognized in 2019= (650,000-216667) = £ 433,333