Question 2 OR (c)
Patent amortisation with a change of method
4 marks
- Time to write
- About 8 minutes
- Notes
- Crux notes
Question
Question 2 OR (c) · 4 marksA company acquired a patent at a cost of ₹24,00,000 for a period of five years, and the life cycle of its product is also five years. The company capitalised the cost and began amortising the asset at ₹3,00,000 per annum. After two years it was found that its product's life cycle may continue for another five years. The product's net cash flows during these 5 years are expected to be ₹10,80,000, ₹13,80,000, ₹13,20,000, ₹12,00,000 and ₹10,20,000. Assuming that the patent is renewed after every five years and the company changed its method of amortisation from 'Straight Line Method to ratio of expected cash flows, find out the amortisation expense of the patent for each of these years.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- Assuming that the patent is renewed…The paper fixes this: use it as given, and say so in your answer.
- find outFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
- The printed annual amortisation (₹3,00,000 in our version) is less than the cost divided by five years (₹4,80,000); the answer uses the printed figure, so the carrying amount after two years is ₹18,00,000.
- "These years" is read as the five further years of the product's life, and the carrying amount is amortised over them in the ratio of the expected cash flows.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Straight-line charge for two years and carrying amount 1 mark 2 min
- 2 Carrying amount spread in the cash-flow ratio over years 3–7 2 marks 3 min
- 3 Change applied prospectively; total ties to cost 1 mark 2 min
Short on time? Step 2 carries 2 of the 4 marks: guard its minutes.
Final answer
Check your own figures against these.
- Years
- 1–2 ₹3,00,000 each
- Years
- 3–7 ₹3,24,000, ₹4,14,000, ₹3,96,000, ₹3,60,000 and ₹3,06,000. The seven charges total the cost, ₹24,00,000
Try it first. About 8 minutes for 4 marks. Write it out, then open the solution and check your figures against the final answer.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Years 1–2 (straight-line, as given). ₹3,00,000 a year. Amortised in two years = ₹6,00,000; carrying amount at the end of year 2 = 24,00,000 − 6,00,000 = ₹18,00,000.
Why the charge changes. AS 26 requires the amortisation period and method to be reviewed at least at each year end. A useful life significantly different from the earlier estimate changes the period, and a significant change in the expected pattern of benefits changes the method; both are accounted for under AS 5. The method should follow the pattern in which the asset's economic benefits are consumed, with straight-line used only when that pattern cannot be measured reliably. Here the expected cash flows give that pattern, so the remaining ₹18,00,000 is spread over the five further years in the ratio of those cash flows. The change is applied from year 3 onwards; years 1 and 2 are not restated.
Total expected cash flows = 10,80,000 + 13,80,000 + 13,20,000 + 12,00,000 + 10,20,000 = ₹60,00,000.
| Year | Basis | Cash flow (₹) | Amortisation (₹) |
|---|---|---|---|
| 1 | Straight-line, as given | — | 3,00,000 |
| 2 | Straight-line, as given | — | 3,00,000 |
| 3 | 18,00,000 × 10.8 ÷ 60 | 10,80,000 | 3,24,000 |
| 4 | 18,00,000 × 13.8 ÷ 60 | 13,80,000 | 4,14,000 |
| 5 | 18,00,000 × 13.2 ÷ 60 | 13,20,000 | 3,96,000 |
| 6 | 18,00,000 × 12 ÷ 60 | 12,00,000 | 3,60,000 |
| 7 | 18,00,000 × 10.2 ÷ 60 | 10,20,000 | 3,06,000 |
| Total | 24,00,000 |
Result: years 1–2 ₹3,00,000 each; years 3–7 ₹3,24,000, ₹4,14,000, ₹3,96,000, ₹3,60,000 and ₹3,06,000. The seven charges total the cost, ₹24,00,000.
Where the 4 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Straight-line charge for two years and carrying amount ₹18,00,000 | 1 |
| 2 | Carrying amount spread in the cash-flow ratio over years 3–7 | 2 |
| 3 | Change applied prospectively; total ties to cost | 1 |
| Total | 4 |
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