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Stellenbosch Laboratories: Financial Accounting and Memos

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1. Stellenbosch Laboratories Ltd manufactures and distributes a wide range of general pharmaceutical products. Selected audited data for the financial year ended 31 December 2010 is as follows:
Gross profit $17 600 000
Profit before income tax 1 700 000
Income tax expense 500 000
Profit for the period 1 200 000
Total assets
Current 7 300 000
Non-current 1 1500 000

The company uses a standard mark-up on cost.From your audit files, you ascertain that total research and development expenditure for the year amounted to $4 700 000. This amount is substantially higher than in previous years and has eroded the profitability of the company. Mr Bosch, the company's finance director, has asked for your firm's advice on whether it is acceptable accounting practice for the company to carry forward any of this expenditure to a future accounting period. Your audit files disclose that the main reason for the significant increase in research and development costs was the introduction of a planned 5-year laboratory program to attempt to find an antidote for the common cold. Salaries and identifiable equipment costs associated with this program amounted to $2 350 000 for the current year.The following additional items were included in research and development costs for the year and are considered reliable:

a. Costs to test a new tamper-proof dispenser pack for the company's major selling line (20% of sales) of antibiotic capsules - $760 000. The new packs are to be introduced in the 2006 financial year.

b. Experimental costs to convert a line of headache powders to liquid form - $590000. The company hopes to phase out the powder form if the tests to convert to the stronger and better handling liquid form prove successful.

c. Quality control required by stringent company policy and by law on all items of production for the year - $750 000.

d. Costs of a time and motion study aimed at improving production efficiency by redesigning plant layout of existing equipment - $50 000.

e. Construction and testing of a new prototype machine for producing hypodermic needles - $200 000. The testing has been successful to date and is nearing completion, with only minor immaterial adjustments to be made. Hypodermic needles accounted for 1% of the company's sales in the current year, but it is expected that the company's market share will increase following introduction of this new machine. In addition Mr Bosch believes that due to the good work and reputation that the company is earning in its field, it should be recognizing goodwill of $100 000, this price being based on a recent offer another firm offered to purchase the firm and would have been the goodwill that company recognized.

Required
Prepare a memo outlining the following:
a. Outline to Mr Bosch the general requirements of AASB 138 as to when this standard allows you to capitalize research and development costs.
b. Respond to Mr Bosch's question for each item above explaining your answer according to AASB138.
c. How to account for the goodwill Mr Bosch wishes to recognize.
d. Calculate the new profit for the period (assume 30% tax rate on any changes) and the new level of current and non-current assets.

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Solution Summary

Instructions for preparing a memo are provided.

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Date: May 20, 2009
To: Mr. Bosch
Financial Director
Stellenbosch Laboratories, Ltd.
From: Name
Partner
Audit Firm
Subject: AASB 138: Accounting for Intangible Assets

________________________________________________________________

Effectively, AASB 138 suggests accounting treatment for identifiable non-monetary assets without physical substance (intangible assets) including research and development costs. For research and development costs to be capitalized, if and only if a firm can demonstrate all of the following:
1. It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity,
2. The cost of the asset can be measured reliably,
3. The technical feasibility of completing the intangible asset so that it will be available for use or ...

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