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Gear Software, a public limited company, develops and sells computer games software. The revenue of Gear Software for the year ended 31 May 2003 is $5 million, the statement of financial position total is $4 million, and it has 40 employees. There are several elements in the financial statements for the year ended 31 May 2003 on which the directors of Gear require advice.
(i) Gear has two cost centres relating to the development and sale of the computer games. The indirect overhead costs attributable to the two cost centres were allocated in the year to 31 May 20X2 in the ratio 60:40 respectively. Also, in that financial year the direct labour costs and attributable overhead costs incurred on the development of original games software were carried forward as work-inprogress and included with the statement of financial position total for inventory of computer games. Inventory of computer games includes directly attributable overheads. In the year to 31 May 20X3, Gear has allocated indirect overhead costs in the ratio 50:50 to the two cost centres and has written the direct labour and overhead costs incurred on the development of the games off to the statement of comprehensive income. Gear has stated that it cannot quantify the effect of this write-off on the current year's statement of comprehensive income. Further, it proposes to show the overhead costs relating to the sale of computer games within distribution costs. In prior years these costs were shown in cost of sales.
(ii) In prior years, Gear has charged interest incurred on the construction of computer hardware as part of cost of sales. It now proposes to capitalize such interest and to change the method of depreciation from the straight line method over four years to the reducing balance method at 30 per cent per year. Depreciation will now be charged as cost of sales rather than administrative expenses as in previous years. Gear currently recognizes revenue on contracts in proportion to the progression and activity on the contract. The normal accounting practice within the industrial sector is to recognize revenue when the product is shipped to customers. The effect of any change in accounting policy to bring the company in line with accounting practice in the industrial sector would be to increase revenue for the year by $500 000.
The directors have requested advice on the changes in accounting practice for inventories and tangible non-current assets that they have proposed.