In the December 2010 past exam paper of F7(international), the question 2, we are asked to calculate the value of the new plant. but why the decontamination cost is added to the value of this plant? and i cannot understand why this decontamination cost give rise to the finance cost.
Thank you very much!! Best wishes.
The decommissioning cost is explained in IAS 37 Provisions and Contingencies. When a licence is granted allowing a piece of plant to be built ( like a power station ) in an F7 situation it is likely that there will be an obligation on the licence holder to decommission that plant after a period of time. It is therefore appropriate to make a provision against that future obligation. The question is “How much to provide?”
The directors should estimate the cost today of decommissioning, put that figure into the future ( say after 20 years the plant has to be demolished, so put the “today” figure 20 years into the future, discount the figure back to present values, and that’s the provision.
Next question “Where’s the Debit?” Normally, an increase on a provision account will be debited ( or, if a decrease, credited ) to the Statement of Income. This original setting up of a decommissioning provision is exceptional! The debit is not to Statement of Income! Instead, it’s debited as part of the cost of the power station, and depreciated over the 20 year life.
Each year, the value of the provision should be re-assessed by the directors. Clearly, their original estimate will not be accurate – it’s an estimate – and their revised figure is subjected to the same treatment. Put it into the future ( 19 years this time ) discount it to present value, compare it with the provision brought forward. The difference is the movement in the provision. That movement is treated as a finance charge in each year’s Statement of Income.
At the end of the next year, re-estimate, put the figure 18 years into the future, discount it, compare with the brought forward …..need I go on?
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