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If a provision is made to cover an obligation payable in 8 years, I understand that the PV of the obligation is calculated first using a discounting factor. Afterwards why is there a finance cost charged every year to the P&L? And what does it mean by ‘unwinding interest’? Why is the unwound interest payment added to the non-current liability in the SOFP?
And I wonder why the discounted provision is Dr to the SOFP first under the relevant non-current asset and depreciation is charged on the combined cost of the NCA+the discounted provision.
The discounted value of provision was also Cr to the Non-current liabilities under Environmental provision.
The finance cost is to reverse the effect of discounting. When we first set up a provision, payable in say 8 years’ time, we assess how much it would cost today, put that figure into the future, and then discount it. As each year goes by, we are one year closer to having to settle that obligation.
So, having calculated the present value of the obligation payable in 8 years’ time, we need to Dr the TNCA and Cr the Long Term Liability. Annual depreciation is now charged on the cost of the asset as increased by the present value of the future obligation.
As each year passes, we unroll the discount – ie take the balance on the provision account, multiply by the company’s cost of capital to find out the value of the unrolled discount, and then account for it ….. Dr Finance Cost in SofIncome and Cr Long Term Liability
Has that answered all your questions?
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