Dowden Machinery Ltd (DML), a reporting entity which distributes heavy-duty equipment to industrial entities, has had a significant increase in sales over the last few years to government departments. By 30 June 2017, the percentage of sales to the government sector had risen to 40% of total sales. 

The shareholders of DML are considering an offer to sell the company to Rawson Roads Ltd and have agreed to an audit of the company by Rawson Roads Ltd’s auditors, Carson. During their investigations, Carson questioned DML’s accounting policies in relation to heavy equipment sales to the government. Sales to government departments were carried out under the following terms. 

1. Sales are made at normal retail prices, and the sales price is payable at the date of delivery of the equipment. Ownership title transfers at the date of delivery. 

2. DML guarantees to repurchase the equipment for a predetermined sum, either at the completion of a specified period of time (normally 2 years), or based on a specified equipment usage factor

3. The purchaser is responsible for normal recurring maintenance on the equipment; however, DML is responsible for providing, at no cost to the purchaser, any maintenance above normal levels. 

4. The purchaser bears the full risk of any loss on the sold equipment once title has passed and up to the date on which the equipment is repurchased by DML or sold to an independent third party. 

DML has followed the policy of recognising revenue on government sales on the date of delivery. The auditors assess that DML’s guaranteed price for repurchase of the equipment, as per (2) above, is quite high, and is likely to lead to 70% of all equipment subject to government sales being repurchased by DML. The auditors further assess that DML is likely to incur losses on resale of some of this repurchased equipment. 

DML has also followed a policy of not accruing any future costs that may be incurred from its maintenance obligations above the normal level.

Required

A.  Briefly discuss how a company such as DML determines whether it is a reporting entity.

B.  In the light of the Conceptual Framework, discuss DML’s treatment in the accounting records of:

1.  The revenue from government sales of heavy equipment, given the guaranteed repurchase option

2.  The treatment of future costs for abnormal maintenance.