CleanAir Ltd (CAL) is a company specializing in design and installation of air-purifying systems in residential, office and light commercial properties. It sells air purifiers (with brand name of “FreeAir”) as part of a combined contract which includes a standard two-month warranty term to ensure the quality of FreeAir and maintenance services for a ten-year period.

The sale price for the combined contract is $6.48 million. If sold separately, the standalone selling price of the FreeAir would be $5.76 million and the standalone selling price of the ten-year maintenance service contract would be $1.62 million. The standard two-year warranty would not be offered without the FreeAir, so the standalone selling price is estimated to be zero.

CAL purchased a patent on 1 January 2017 for $18 million from a world class scientist who has registered the patent on 1 January 1972. The legal right of the patent was set at 50 years from the date the patent was originally registered and the patent was amortised by CAL on a straight-line basis over the remaining patent period. However, recent legislative changes passed on 1 January 2020 have extended the patent period by 20 years, to 70 years.

CAL has an active research and development department on biotechnology and was completed a development project in December 2019 with a cost of $7.56 million which is intended to be amortised over 5 years on a straight-line basis from 1 January 2020. The result of such development project will be used internally and also sold to other companies.

Unfortunately, a competitor’s product reached the market first and external sales of the new technology were much lower than expected in 2020. Revised cash flow budgets prepared at 31 December 2020 show the following revised budgeted amounts over the life of the product:

Year ending 31 December 2021 Year ending 31 December 2022 Year ending 31 December 2023 Year ending 31 December 2024

Net cash inflow $1,440,000 $1,080,000 $900,000 $540,000

t PVF t, 5% 1 0.95238 2 0.90703 3 0.86384 4 0.82270

Net cash inflows can be assumed to occur at the end of each year. The annual interest rate CAL uses for discounting cash flows is 5%. The external market value would be lower than the value in use of the development cost as at 31 December 2020.

Required:

Round all figures to the nearest dollar.

1. (a) Advise the directors of CAL on how to account for the sale contract of FreeAir with reference to HKFRS 15 ‘Revenue for Contracts with Customers’. No entries are required in your answer but your answer should involve the discussion of 5- step model. 

2. (b) Prepare the journal entries to account for amortization of the patent for the year ended 31 December 2020. 

3. (c) Determine the impairment loss as a result of the impairment review carries out at 31 December 2020 and prepare necessary journal entries for CAL of this development cost for the year ended 31 December 2020. 

Answer rating: 100% (QA)

Solution for Option a Accounting for the Sale contract of FreeAir with reference to IFRS15HKFRS 15 Revenue for Contract with Customers IDENTIFYING PERFORMANCE OBLIGATIONS Under the five step model of ... View the full answer