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Question) Shawler constructed a furnace on 1 april 20X3, causing significant environmental damage which must be repaired at the end of the asset’s useful life of 10 years. The present value of this is estimated to be $4million. Shawler has a cost of capital of 8%.
What is the total finance cost to be recorded in the statement of profit or loss in respect of the environmental damage caused by the furnace for the year ended 30 june 20X5?
Answer: $320 000
Hi sir, for the above question, the finance cost until 31 march 20X4 is $320 000 right? But the question states” for the year ended 30 june 20X5″ so how can the answer still be $320 000 . Could you explain sir ?
The key is in this sentence … “The present value of this is estimated to be $4million”
If the question had said “The present value of this WAS estimated to be $4million at the time of construction” then the finance charge for the first 3 months to 30 June, 2013 would have been $80,000, for the second year (to 30 June, 2014) $326,400 and for the year to 30 June, 2015 it would have been $352,512
But the question tells you what the present value IS, not what it WAS
OK?
Okay. So if the question had said “The present value of this WAS estimated to be $4million at the time of construction” then the finance cost for the year ended 30 june 20X5 would be as follows
(in ‘000)
Year ——————- Br. forward — Finance cost (8%) — Carried forward (NCL)
1(31 mar 20×4) ——–- 4000 —————–-320 ———————–4320——————
2(31 mar 20×5) ——— 4320 —————–346 ———————–4666——————
3(31 mar 20×6) ——— 4666 —————–373 ———————–5039——————-Since 30 June 20X5 falls within the third year, therefore the finance costs for the year ended 30 june 20X5 would be $373.
Am I right sir ?
Likewise, since the question says “The present value of this IS……” therefore, the finance cost for the year ended 30 june 20X5 would be as follows
4000 x 8% = 320
Why is this so ? Does it mean that the date doesn’t matter if the question says the present value of this IS”? If for example, the question asked for the finance cost for the year ended 31 August 20X7, would it still be $320? Could you explain sir ?
Dates ARE important
For the accounting period ended 30 June 2013, the finance cost would be 3/12 * 8% * $the present value at date of construction
That would be added to the present value at date of construction (which you haven’t told me and I’m really, really hoping that it’s not some vital piece of information that you have kept from me)
But because we don’t know that present value at date of construction, all we have is the present value per the question that we have to assume is the brought forward present value
Now we need to unwind that $4,000 present value brought forward by 8% for the year ended 30 June 2015 and that’s where the $320,000 comes from
If the question had specified that $4,000 was the present value brought forward and then asked “What would be the finance cost for the year 2017?” the calculation would have been …
$4,000 + $320 + $4,320 carried forward at 30 June, 2015
$4,320 + $345.6 + $4,665.6 carried forward at 30 June, 2016
$4,665.6 + $373.248 = $5,038,848 carried forward at 30 June, 2017“Does it mean that the date doesn’t matter if the question says the present value of this IS”? If for example, the question asked for the finance cost for the year ended 31 August 20X7, would it still be $320?”
Of course it matters – the question has to tell you the date at which the present value has been calculated
If the question is asking you about finance costs for the year to 30 June, 2017, the present value will either be ‘as at 1 July, 2016′ or the question will give you the precise date and you would need to calculate previous years’ un-windings … but that’s highly unlikely
Okay, so if the question says “The present value of this IS $4million……” and if the question initially asked what is the finance cost for the 30 june 2019 ?
Then we have to assume that the present value of $4m is the brought forward present value and therefore the finance cost for 30 june 2019 is
$4million x 8% = $320 000
And if the question subsequently asks what is the finance cost for 30 june 2020, it is as follows:
$4,000 + $320 = $4,320 carried forward at 30 June 2019
$4,320 + $345.6 = $4,665.6 carried forward at 30 June 2020Basically we just got to assume that the present value given is the brought forward present value to which ever date they initially asked the finance cost for. Then subsequently, if we are asked for the finance costs for the other years , we just base our working from there.
Am I right sir ?
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