Question 2 OR (a)
Patent amortisation with a change of method (AS-26)
8 marks
- Time to write
- About 16 minutes
- Notes
- Crux notes
Question
Question 2 OR (a) · 8 marksA company acquired a patent at a cost of Rs. 60,00,000 for a period of ten years, and the life cycle of its product is also ten years. The company capitalised the cost and began amortising it as per AS 26. Two years later it was found that the product's life cycle may continue for only another five years. The product's net cash flows during these 5 years are expected to be 10,00,000, 12,00,000, 14,00,000, 11,00,000 and 13,00,000. Find out the patent's amortisation expense for each of these years company changed its amortisation method from straight line method to the ratio of expected cash flows.
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
- Find outFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
- The patent is amortised on the straight-line method over ten years for the first two years.
- "Each of these years" is read as the five remaining years, and the last sentence as saying that the company changed the method from straight line to the ratio of the expected cash flows; the carrying amount after two years is spread over those five years in that ratio.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Straight-line amortisation and carrying amount at the change 3 marks 5 min
- 2 Prospective amortisation over the remaining life in the cash-flow ratio 5 marks 9 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Final answer
Check your own figures against these.
- Amortisation for years
- 3 to 7 is ₹8,00,000 / ₹9,60,000 / ₹11,20,000 / ₹8,80,000 / ₹10,40,000, which together fully amortise the ₹48,00,000 carrying amount over the revised remaining life
Try it first. About 16 minutes for 8 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.
The cost of an asset is written off by a systematic method over its useful life; under the straight-line method a fixed percentage of the original cost is written off every year. AS-26 requires the amortisation period and method to be reviewed at least at each financial year end: where the expected useful life is significantly different, the period is changed, and where the expected pattern of economic benefits has changed significantly, the method is changed to reflect it. A change in the amortisation method or period is a change in an accounting estimate, disclosed under AS 5. It is therefore applied from the review onwards, to the carrying amount then left, over the revised remaining life; years 1 and 2 are not restated.
Step 1: carrying amount at the date of change
Straight-line amortisation for years 1–2 = 60,00,000 ÷ 10 = ₹6,00,000 per year.
| Cost of the patent, split at the date of change | ₹ |
|---|---|
| Amortised in years 1–2 (6,00,000 × 2) | 12,00,000 |
| Carrying amount at the date of change | 48,00,000 |
| Cost of the patent | 60,00,000 |
Step 2: amortisation over the remaining five years (cash-flow ratio)
Total expected cash flows = 10,00,000 + 12,00,000 + 14,00,000 + 11,00,000 + 13,00,000 = ₹60,00,000. The carrying amount of ₹48,00,000 is apportioned in that ratio:
| Year | Expected cash flow (₹) | Amortisation = 48,00,000 × CF ÷ 60,00,000 (₹) |
|---|---|---|
| 3 | 10,00,000 | 8,00,000 |
| 4 | 12,00,000 | 9,60,000 |
| 5 | 14,00,000 | 11,20,000 |
| 6 | 11,00,000 | 8,80,000 |
| 7 | 13,00,000 | 10,40,000 |
| 60,00,000 | 48,00,000 |
Result: amortisation for years 3 to 7 is ₹8,00,000 / ₹9,60,000 / ₹11,20,000 / ₹8,80,000 / ₹10,40,000, which together fully amortise the ₹48,00,000 carrying amount over the revised remaining life.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Straight-line amortisation and carrying amount at the change (₹48,00,000) | 3 |
| 2 | Prospective amortisation over the remaining life in the cash-flow ratio | 5 |
| Total | 8 |
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