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Hello Tutor
Extract from BPP F7 practice question bank:
A company set up a gas exploration site on 1 Jan 20X1 which will operate for 5 years. At the end of 5 years the site will need to be dismantled and the landscape restored. The amount required for dismantling and restoration, discounted at the company’s cost of capital of 8%, is $1.2m and a provision is set up for this amount. What is the total amount charged to P&L for the year end 31 Dec 20X2 in respect of these dismantling and restoration costs?Answer: Depn 1.2m/5 240,000
Unwinding of discount (1.2m x 1.08)x8% 103,680
= 343,680I don’t understand the Unwinding of discount (1.2m x 1.08)x8% bit? Is it like a consideration transferred but opposite?
Thank you in advance!!
Not quite – it’s like we have in consolidations – it’s deferred consideration
In this question, the true cost of dismantling at “today’s rates” was $1,763,194
It was. Believe me, but don’t ask me to tell you how I know because you don’t need to know
Today, we say to ourselves, to dismantle this gas exploration site, if we had to do it today, would cost us $1,763,194
Ok, let’s put that figure 5 year’s into the future and then discount it to see what the equivalent is in today’s money of that $1,763,194
$1,763,194 x 1/1.08 = $1,632,587 if we discount for just 1 year
$1,632,587 x 1/1.08 = $1,511,654 if we discount for 2 years
$1,511,654 x 1/1.08 = $1,399,680 if we discount for 3 years
$1,399,680 x 1/1.08 = $1,296,000 if we discount for 4 years
$1,296,000 x 1/1.08 = $1,200,000 if we discount for 5 yearsSo the present value of $1,793,194 payable in 5 years’ time is $1,200,000 and that’s the figure that we will ….
Dr Gas Exploration Site, Cr Provision
After 1 year, we are only 4 years away from having to dismantle so that provision should now be $1,296,000 and we need therefore to ….
Dr Finance Costs, Cr Provision with $96,000 and the Provision now stands at $1,296,000
After the second year, the unrolling involves $1,296,000 x 8% and that’s $103,680
Instead of setting it out one year at a time, BPP have applied 8% to $1,296,000 but have shown $1,296,000 as $1,200,000 x 1.08%
Hence their line of ($1,200,000 x 1.08%) x 8%
I’m sure that’s way over the top as an explanation but others may benefit from the detailed explanation
OK?
Hello,
to the issue of unwinding, NPV, NBV, gross carrying value and allowance under IFRS 9:
IAS 39 defines EIR (except of POCI assets) to calculate over the expected cash flows without including credit risk. (output is NPV, but without incorporated possible future defaults or pastdue payments). I do not understand it as the total NPV for the instrument, because credit risk is missing.
Credit risk is incorporated in ECL (EAD*LGD*PD*CCF),… – if an entity uses IRB approach for allowances.
If we sum the two following parameters:
EIR*NPV(wo credit risk) and ECL (=credit risk in term of dollars), we get the total impairment for the period.
This means: unwind + loss allowances = total impairment.
If total impairment = Gross carrying amount minus NPV, this is not compliant with the previous calculation, where NPV did not contain credit risk.what is the understanding of NPV without credit risk and how could you explain the effect on the unwinding?
It seems, there should be two different NPVs: wo and with credit risk…
thank you for clarification.
Whatever it is that you’re on, you could make a fortune selling it!
We’re looking at F7 here. Where do you think that you could bring into an F7 answer “Credit risk is incorporated in ECL (EAD*LGD*PD*CCF),… – if an entity uses IRB approach for allowances”?
The F7 examiner even tells you to ignore the time value of money in questions such as those that involve the accounting for construction contracts – there’s little or no chance that you’re going to get the opportunity to impress with this until you’re facing P2 and even then it’s unlikely
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