Electron – Pilot Paper

Question: Electron has recently constructed an ecologically efficient power station. A condition of being granted the operating licence by the government is that the power station be dismantled at the end of its life which is estimated to be 20 years. The power station cost $100 million and began production on 1 July 2005. Depreciation is charged on the power station using the straight line method. Electron has estimated at 30 June 2006, it will cost $15 million (net present value) to restore the site to its original condition using a discount rate of five per cent. Ninety-five per cent of these costs relate to the removal of the power station and five per cent relates to the damage caused through generating energy. Answer: Power Station Under IAS37 Provisions, Contingent Liabilities and Contingent Assets, a provision should be made at the balance sheet date for the discounted cost of the removal of the power station because of the following reasons: (i) the installation of the power station creates an obligating event (ii) the operating licence creates a legal obligation which is likely to occur (iii) the costs of removal will have to be incurred irrespective of the future operations of the company and cannot be avoided (iv) a transfer of economic benefits (ie the costs of removal) will be required to settle the obligation (v) a reasonable estimate of the obligation can be made although it is difficult to estimate a cost which will be incurred in twenty years time (IAS 37 says that only in exceptional circumstances will it not be possible to make some estimate of the obligation) The costs to be incurred will be treated as part of the cost of the facility to be depreciated over its production life. However, the costs relating to the damage caused by the generation of energy should not be included in the provision, until the power is generated which in this case would be 5% of the total discounted provision. The accounting for the provision is shown in Appendix 1.