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A company was awarded a licence to quarry limestone in an area of outstanding natural beauty.
As part of the agreement, the company was required to build access roads as well as the structures necessary for the extraction process. The total cost of these was $50 million. The quarry came into operation on 31 December 20X3 and the operating licence was for 20 years from that date. Under the terms of the operating licence, the company is obliged to remove the access roads and structures and restore the natural environmental habitat at the end of the quarry’s 20-year life. At 31 December 20X3, the estimated cost of the restoration work was $10 million, and this estimate did not change by 31 December 20X4. An additional cost of $500,000 per annum the quarry is operated (at 31 December 20X4 prices) will also be incurred at the end of the licence period to clean up further progressive environmental damage that will arise through the extraction of the limestone.
An appropriate discount rate reflecting market assessments of the time value of money and risks
specific to the operation is 8%.Hello Sir, My question is related to the 500,000 additional cost,
the answer says that corresponding debit entry would be to P&L, however I feel like it should be adjusted in asset’s cost and depreciated
As the answer also says in the end that changes in PV of provision should be adjusted for in the cost of asset.The 500,000 damage is not caused by the construction of the mine but by the extraction of the mineral. It’s a bit like a friend coming round to your house every Tuesday who, every week, spills a bit more coffee on your carpet.
So, arguably, a provision is not needed until construction starts. Dr P&L Cr Provision
I wouldn’t worry about the discounting on this extra 500k cost. Whatever you are inferring from the answer, it definitely won’t affect the asset valuation.
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