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….At 1 dec 08, the carrying amount of decommissioning liability has grown to $32.6 m, but the net present value of decommissioning liability has decreased to $18.5m as a result of the increase in the risk adjusted rate.
Could you kindly explain the above lines?
When establishing a provision for decommissioning (which event could be 20+ years in the future) the provision is calculated by considering “How much would it cost us today to decommission the power station?”, put that figure 20+ years into the future and then discount using the company’s cost of capital. The resultant figure is the amount to capitalise and provide (Dr TNCA and Credit Provision)
Next year, we do the same exercise but discount for one fewer year because we are one year closer to having to do the work.
Now, in that year just gone by, clearly our estimate of the likely cost of decommissioning could change (“How much would it cost today to decommission?”, put the figure 19 years into the future and discount)
But our cost of capital could also have changed.
Your post suggests this latter cause – the discount rate has increased so the present value of the forecast cost of decommissioning has fallen
As for “risk adjusted rate” – the projected cash costs should take into account risk unless the discount rate itself takes it into account. But only one, either the rate applied or the projected cash flow, should be adjusted for risk – otherwise you’ll have a double-adjustment
OK?
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