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Question Nette…. (extract)
Nette has recently constructed a natural gas extraction facility and commenced production one year ago (1 June 2003). There is an operating licence given given to the Co. by the government that requires the removal of the facility at the end of its life which is estimated at 20 yrs. Depreciation is charged on the straight line basis. The cost of the construction of the facility was $200m and the net present value @ 1st June 2003 of the future costs to be incurred in order to return the extraction site to its original condition are estimated at $50m (using a discount rate of 5% per annum). 80% of these costs relate to the removal of the facility and 20% relate to the rectification of the damage caused through the extraction of the natural gas. The auditors have told the Co. that a provision for decommissioning has to be set up.
Required:
Explain with reasons and suitable extracts/computations the accounting treatment of the above situation in the Financial statements for the year ended 31st May 2004.I’m having issues with the answer in the kit which they accounted the provision as follows:
PV of obligation @ 1st June 2003 $50
Provision for decommissioning 80% * 50m 40Provision for damage through extraction
(20% * 50m * 1.05^20) /20 1.33Also a SOFP & SOCI extract was done. (Too much to type.)
Can u please tell me the best approach to this question and reasoning behind these figures PLEASE. Your help would be greatly appreciated. Thanks in advance.
Hi Linda – I presume you don’t have problems with 5%, 80% nor 20% nor with $200m nor $50m. As at the start of this year, 1 June 2003, need to create a provision of 80% * 50m = 40m. This needs to credit a provision account and debit the extraction facility which will then be depreciated over 20 years. I know you’re ok with that. We need also to create a provision for rectification which we shall build up by unrolling to reach the level of $X in 20 years’ time but with a present value of 10m one year ago( 20% * 50m ). Need to unroll the 50 by one year at 5%. Of this amount ( 2.5m ) 80% will debit finance charges in I/S and credit the provision for decommissioning. the other 20% will debit finance charges and credit the provision for extraction damage. ( I don’t understand the ^ symbol in your post )
In my head, I now have an asset $200 + 40m – depreciation of 12m = 228m.
In I/S I’ve got 12m depreciation
On SoFP, I’ve got a provision for decommg of 40 + 2 ( unrolled at 5% for 1 year ) = 42
and a provision for restoration of damage of 10 + .5 ( again, unrolled )On SoI I’ve got finance charges of ( 40 + 10 ) * 5% = 2.5
I seem to remember that the original question said that extraction had not yet commenced so there was a little trick that no provision would be created for extraction damage until extraction had actually started.
Does that help?
Thanks Mike for your quick respond.
Your method seems better than what the book did. In the kit they have the unwinding amount for the Provision of decommissioning of 40*5%=2, which you did as well.
However for the Provision for the damage shown in their SOFP EXTRACT is 1.33 ((20% * $50*1.05^20)/ 20 years). This 1.33 figure was also shown in the SOCI extract and it’s this figure(1.33) that I don’t understand. Don’t know if Kaplan is trying to play with my head because this is a headache I can do without.no problem – I just hope I’m correct. I cannot see where 1.33 comes from
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Hi Linda, very confusing question
I understand 1.33 in the following way, the Present value of the cash outflow for the extraction of damage is equal to 10 mln, and 1.05^20 is equal to 2.65, that means 0,5 mln expense made now (10m*5%) 20 years later would be 0,5*2,65 and which is equal to 1,326, but still there is no any sense in presenting it in I/S, except where 5% percent is not effective interest rate.
Can this version be right Mike???I still don’t understand the symbol ^ It keeps appearing in this stream and I don’t know what it means. I need to know before I can answer!
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like 2*2*2*2=2^4 I don’t now the english name for it(
Ah! “2 to the power 4”
Now, it seems that Kaplan have grossed up the figure to find the amount in 20 years’ time and then simply divided that by 20 to give a straight line increase in the provision.
I don’t know why! maybe there’s something in IAS 37 which says that’s what you should do! If my way is incorrect, I’m sorry. But it’s what I would have done in an exam situation!
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