Question 3 Go to the Xero Limited web site (www.xero.com.au). Scroll to the bottom of the page and select INVESTORS and then select Financial info. Download the 2020 annual report. Required (a) Review the Notes to the Financial Statements sections, specifically Note 4 Revenue'. Explain the different forms of revenue recorded by Xero and the different ways the company recognises each type of revenue. (6) Are Xero's methods of revenue recognition consistent with the revenue recognition criteria discussed in chapter 3 of the text? (c) What are the sources and amounts of revenues in the 2020 annual report? Explain the distinction between revenue and other income as disclosed in the financial statements. Income Statement Year ended 31 March Notes 2020 ($000s) 2019 ($000s) 538,384 Subscription revenue Other operating revenue Total operating revenue 696,220 22,011 718,231 14,435 4 552,819 Gross profit Gross profit represents operating revenue less cost of revenue. Cost of revenue consists of expenses directly associated with securely hosting Xero's services, sourcing relevant data from financial institutions, and providing support to subscribers. The costs include hosting and content distribution costs, bank feed costs, personnel and related expenses (including salaries, benefits, bonuses, and share-based payments) directly associated with cloud infrastructure and subscriber support, contracted third-party vendor costs, related depreciation and amortisation, and allocated overheads. Year ended 31 March 2020 ($000s) 2019 ($000s) change 30% 552,819 (90,915) 17% Operating revenue Cost of revenue Gross profit Gross margin percentage 718,231 (106,582) 611,649 85.2% 32% 461,904 83.6% 1.6pp Gross margin increased by 1.6 percentage points to reach 85.2% for FY20. This was driven by operating revenue growth of 30%, as well as efficiencies in cost of revenue. This resulted in gross profit increasing by $149.7 million, or 32%, to $611.6 million. Cost of revenue for FY20 grew by $15.7 million to $106.6 million, representing a 17% increase when compared to FY19. The primary reasons for the change in cost of revenue were increases in personnel costs related to higher headcount in Xero's customer support teams, and increased cloud hosting costs. Growing use of Xero Central (launched in FY19) and hosting cost efficiencies were the main drivers of improvement in gross margin. There has been an emphasis on customer self-service with the aid of machine learning, via Xero Central, which has helped offset the need for additional customer experience headcount as we continue to scale. Xero has also realised efficiencies in hosting through optimising the Amazon Web Services (AWS) product mix and reducing wastage by scaling resources to reflect actual user load at any given time
