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A company estimated decommissioning costs of $500,000 for its plant costing $1 m on 1st January 2008.
On 31st December 2011, there was a change in the useful life of the asset from 20 years to 18 years from the original assessment.
Depreciation is charged at the year end, and in 2011 the company had recorded a surplus of $400,000.
The change in useful life has changed the estimation of decommissioning cost to $450,000.Required:
If discount rate is 9%, show the accounting adjustments on 31st December 2008 and 31st January 2011.With Mr Mike not appearing often i thought i would try to answer this – but if he sees it he may say its not right!
the change in the estimated decommissioning costs is surely a change in accunting estimate and is effective only going forwards – so no retrospective adjustment. Similally the change in estimated useful life is a change in accoujnting estimate and again no retrospective adjustment
Not sure what you mean by “the company had recorded a surplus of $400,000.” is that profit for the year? Before or after depreciation charge for the year? depreciation should be charged on the revised carrying value over the revised useful life
your question askes for adjustments as at 31 December 2008 – i dont think there are any – all the adjustments are revisions of accounting estimates and so no backwards adjustments
If Mike sees this I hope he says its correct 🙂
Thanks for your response despite Mike’s absence @ gingergirl.
Your mention of no retrospective treatment did thankfully remind me of what I studied about prospective treatment of changes in accounting estimates, so I am sure you are totally right about that bit.
That surplus I mentioned is the revaluation surplus (‘notional’ gain produced upon subsequent revaluation). I would suppose that’s right after the change in original assessment.
Are you entirely sure there will be no accounting adjustments, or any sort of workings to show, for the year ended 31st December 2008? Even if not, I think you missed the other year for which the question asks for accounting adjustments (ie. 31 December 2011). 😀
Your help is highly appreciated, by the way.
The question asks for accounting adjustments ON 31 December 2008. I misread that as FOR as in, now we are in 2011, what adjustments will you make to the figures from 3 years ago. My bad, sorry.
For 2008, 500,000 will be capitalised and depreciation charged on 1.5m over 20 years so by the time 31.12. 11 comes along we have deprecated 4 years already so cv is now 1.2m Now you say estimated life is revised to 18 so there is only 14 more years to go.
Now you revalue upwards by 400,000 so 1.2m increases to 1.6m, weve got the figure to be deprecated over the remaining 14 years.
Finally we need to recalculate the amount of the decommissioning but i dont know wether the 450,000 is a straight replacement of the original 500,000. Are you saying that the 50,0000 estimate from 4 years ago should have been only 450,000 or are you saying that 4 years after starting the decommissioning costs are estimated to be at TODAYS prices 450,000. If thats what your saying we should discount 450,000 for 14 years at the cost of capital, compare that with the amount of the existing provision and make the necessary adjustment to the provision account, up or down, with the double entry going through this years income statement.
Thats what i think – but i could so easily be wrong. but what a great question -wheres it from?
Thank you so very much for such an elaborate response, Ma’am.
I am only guessing this at this point since I don’t have an explanation of the question yet but the revised $450,000 is what 4 years after starting the decommissioning costs are estimated to be at TODAYS prices (based on the fact that “the change in useful life has changed the estimation”).
The question was designed by my own P2 trainer and she is really good at it. I just hope atleast some of her brilliance in regards to Accounting and Reporting can rub off on me sooner rather than later. :p I will be discussing the question in further detail tommorrow since I had days off till today.
Anyway, I so totally appreciate your time and patience here and the fact that you actually assisted through the entire question in good detail.
Thanks once more, and stay blessed.
your welcome – let me know please if your teacher agrees. where are your courses coz your teacher sounds really good
Sure, I shall let you know as soon as she checks it and produces the solution herself.
Without doubt, she knows her stuff pretty well. We are based in Rawalpindi, Pakistan. Thanks for asking. 🙂
So I consulted my teacher regarding the solution to the problem and the outline she provided was rather different. I thought I should share it here as I worked through the solution so that a) Mike could later confirm the appropriateness and b) Others could benefit. Here goes:
IAS-37 Provisions, Contingent Liabilities and Contingent Assets determines the accounting treatment for provisions such as decommissioning costs of $500,000. These costs will be capitalized in the cost of the asset in accordance with IAS-16 Property, Plant and Equipment using its discounted value:
[500,000 x (1+0.09)-20] DR Asset 89216
CR Provision 89216An interest of $8029 (89216 x 9%) will be recorded as expense and the asset will be depreciated at $54461 [1000000+89216/20], giving a Net Book value of $1034755 (1089216-54461).
As for 31 December 2011, the Net Book Value produced will be $871372 [1089216-(54461 x 4)]. Since the change in provision is given as a decrease of $50000 (500000-450000), the resulting gain will be added to revaluation reserve and provision will be debited by the same amount using discounted value:
(50000 x 1.09)-18 DR Provision 10600
CR Revaluation Reserve 10600Hi Hassan
I’ve checked through the thread and have these comments.
Gingergirl appears to have forgotten to unroll the discounted provision (Debit Finance Charges, Credit Provision) – I’ve only had a quick look so she MAY have included it but I didn’t spot it in there.
I sympathise with her because your question was vague! “On 31st December 2011, there was a change in the useful life of the asset from 20 years to 18 years from the original assessment.” I would read that the same way the Gingergirl has – that useful life SHOULD HAVE BEEN ESTIMATED at 18 4 years ago when useful life was estimated at 20 years. That, so far as Gingergirl and I am concerned is a change in an accounting estimate. Such changes in provisioning go through Statement of Income
I think, from reading Gingergirl’s posts that she got the capitalisation and depreciation correct without actually working out what 500,000 discounted for 20 years is (her words were sufficient to indicate that that was what was required)
In summary, you say that your teacher’s answer is “rather different” but I would disagree – apart from the number of years involved (your misleading question!) and the different accounting treatment of the revision to the provision (again partly caused by the misleading wording) I would suggest the Gingergirl’s answer was virtually the same as your teacher’s. The one big(gish) area where we disagree is in the double entry for the revisiion of the provision caused by the revision of an accounting estimate.
Your teacher says put it through Revaluation Reserve and I would suggest that, because it’s a revision of an accounting estimate affecting the value of a provision, it should go through Statement of Income. In fact, there was a past exam question many years ago that required precisely that treatment.
I’m NOT going to say that she’s wrong (your teacher) but it might be worth you checking in IAS 16 to see quietly whether Gingergirl and I are correct or whether “Teacher” has the edge
Gingergirl, if you read this, I think that was a brave effort on your part
Glad to hear from you, Mike.
I apologize for what appears to be a vaguely worded question to both of you. I tried to keep it simple but my mistake that I ended up making it seem complicated.
Could you please be clearer in regards to what extent you agree with the solution I provided in my response above? The teacher simply gave me an outline to the answer so it is very much possible that I misunderstood what was said since I completed the solution, with the figures included, on my own.
I am assuming that the cost model was supposed to be followed throughout here in this question, which is why there should not have been any mention of a Revaluation Reserve maybe and the revised provision only capitalized as a result? (Revaluation Reserve only comes into play when fair value model is adopted?)
I wish you can spare time and clarify this, and possibly guide through the entire problem with the help of given numbers.
Pardon me if I am asking for too much,I appreciate your time and effort anyway,
Thank you.
Hi again
My understanding is that, having set up the original provision and capitalised it, any subsequent revisions are adjusted through Income Statement
Is that ok for you?
Hello again.
How exactly would you deal with the subsequent revision in the Income statement? I understand the bit about unwinding and recording finance cost but the subsequent measurement is what is confusing me here.
Thanks in advance,
Debit or credit the provision and credit or debit the Statement of Income
Thanks for the help, Mike. I printed all the responses and showed them to my tutor for further clarification. She agrees that the way I have presented the question (with the kind of spacing) causes some confusion in the mind of the reader as to what exactly the problem at hand is. Her question basically asked for accounting treatment in regards to the change in provision (which I didn’t quite mention anywhere but the title has a hint). If you notice, the title of the question specifically mentions IFRIC 1. IAS-16 does not cover ‘change’ in liabilities such as decommissioning, restoration etc. and the treatment that follows; IFRIC-1 was meant for that purpose.
I’ll quote the relevant portion of the standard right here: “Where entities account for their property, plant and equipment using the fair value model, a change in the liability does not affect the valuation of the item for accounting purposes. instead, it alters the revaluation surplus or deficit on the item, which is the difference between its valuation and what would be its carrying amount under the cost model. The effect of the change is treated consistently with the other revaluation surpluses or deficits. Any cumulative deficit is taken to profit or loss, but any cumulative surplus is credited to equity.”
There was also confusion about the change in decommissioning cost as to whether it was a straight replacement or otherwise, but the question clearly stated it is a change due to change in useful life.
I’ll reiterate that IFRIC-1 is what was mainly followed in the solution of the problem in regards to the provision and its subsequent treatment.
Also, gingergirl rightly said that the change in useful life is a change in estimate as per IAS-8 but the remaining useful life is still assumed to be 18 years following prospective treatment; not 14 years as per the solution I provided.Before I conclude, I would like to emphasize that this is purely a response from my tutor and what came about after I had a discussion with her today. I am still as thankful to the both of you for assisting me as best as you could with the given information. Accept my apologies if my response here was awry in any way,shape or form.
I hope to have your response on this, nonetheless.
Kind Regards.
Hi Hassan
Thanks for posting this and Im glad that Mike was equally misled as I was. I didnt mention unwinding the discount – sorry. Tricky question from start to finish!Hmm, re paragraph 2, I think the only difference between what you have written and my own effort is the treatment of the surplus arising from an increase in the estimated decommissioning costs (mine went to Income Statement, yours to Revaluation Reserve)
The other area causing divergence was the misinterpretation of 14 / 18 years (“On 31st December 2011, there was a change in the useful life of the asset from 20 years to 18 years from the original assessment.”) Based on yet another re-reading of that note, I still interpret that as “4 years ago it should have been estimated at 18 years, so it still has 14 years left to run”
re that Revaluation Reserve credit for a reduction in the discounted provision – well, I’m going to have to look again at IFRIC1. I’m sorry to say this, but I’m still not totally convinced by your post.
Kindly do look up IFRIC-1 when you have time to spare so that you can be sure if what I quoted satisfies. The change to the useful life is made at the end of year 2011 when 4 years have already passed. Technically, it should have been 16 years left, but the change is applied prospectively and complete 18 years counted from that point of change as a prospective treatment to the change in estimate.
@gingergirl Nevermind the mistake; you were kind enough to try and assist me with the problem. I thank the both of you for that effort.The reference to original assessment means 20 was the original assessment but the mention of 31 December 2011 implies that it changed at that particular date.
I think the confusion also spurs because the question is an extract, which wasn’t meant to be detailed since the teacher had just taught IFRIC-1 and was mainly testing students on that particular standard.
I hope that clears some confusion.
Ok, so my teacher was keen enough to look up the original adaptation of the question and just emailed me saying that her version was cut short of “remaining useful life of 18 years at 31 December 2011 when the original assessment had been 20 years initially.”
As I previously mentioned, the original question was cut short as the focus was on IFRIC-1 and also because of shortage of time.
Ah – that makes sense. Thanks again for posting – I don’t feel quite so stupid now I know that it was a condensed question!
🙂
I am SO glad I was able to convey the messages, properly. Thank you so so much for keeping up with my lengthy responses and taking out the time to participate in the discussion, Sir.
Stay blessed.
Thanks for your good wishes, and thank you also for posting such an interesting question – it was fun trying to unravel it!
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