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Hello sir. This is part of a question from section B of revision kit.
In 5 years time Rainbird will have to dismantle its factory and return the site to the local authority. A provision was set up for the present value of the dismantling costs when the factory was first acquired.The opening balance on the provision at January 20X1 was $2.63 million. Rainbird has a cost of capital 8%.
What is the amount of the provision that should be carried forward at 31 December 20X1 for the dismantling of the factory?Please could you explain how to proceed?
having set up the provision on day one at its present value, discounted at the entity’s cost of capital, we now need to unroll that discount
So we need to multiply $2.63 million by 1.08 and that gives us a provision to carry forward as at 31 December, 20X1 of $2.84 million
Incidentally, the carry forward amount at the end of 20X2 would be $2.84 x 1.08 = $3.07
For 20X3, the carry forward would be $3.31 and
for 20X4, the carry forward would be $3.58 and
as at the end of 20X5 the provision would be increased to $3.86 at which time Rainbird will need to restore the site to the local authority and will incur the cost of $3.86
The double entry will therefore be, on 31 December, 20X5:
Dr Provision $3.86
Cr Cash $3.86OK?
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