ASSET DECOMMISSIONING PROVISION OR ASSET RETIREMENT OBLIGATION
Asset Decommissioning is also generally referred to as Asset Retirement Obligation(ARO). IAS 37 Provisions, contingent liabilities and contingent assets, issued by IASB (International Accounting Standards Board) discusses asset decommissioning. As per the standard asset decommissioning is done to a tangible long lived asset. For example, if an entity decides to undertake a mining activity and end of the mining activity, it takes responsibility to restore the land or modify it to its original condition, it becomes an obligation for the entity to decommission the asset.
The decommissioning obligation need not necessarily be a legal obligation, it could also be a constructive obligation. An obligation is said to be constructive if
asset decommissioning provisions constructive obligation
a) The entity by its actions has established a pattern from its past practice and has indicated to the other parties that it will accept certain responsibilities.
The entity by its actions has some published policies has indicated to other parties that it will accept certain responsibilities
The entity by a specific current statement has indicated to other parties that it will accept certain responsibilities.
b) If the entity by its actions has created a valid expectation on other parties that it will discharge those responsibilities.
A decommissioning provision has to be recognized as a liability if the following conditions are satisfied
1) The entity has an obligation which is current. (Present Obligation). The present obligation should be as a result of past events. Hence recognize the liability only to the extent of damage caused by the entity.
2) There is a probability that there could be outflow of benefits from the entity in order to settle the obligation.
3) If the entity can make a reliable estimate on the amount of obligation. There could be instances where a reliable estimate on the amount of obligation could not be made. In those cases, the liability cannot be recognized, but should be disclosed appropriately.
Note: The obligating event will occur in the year in which the damage or changes to the land or property was made by the entity. Hence the provision must be recorded in the year of damage or in the year major changes were made to the property or the land.
A provision usually means an estimate. Estimates should be made in the best way possible. Usually estimates are best recommended to be made using best judgement, or referring to similar transactions in the same industry or by referring to reports prepared by independent experts.
Time value of money should be considered in estimating the provision as it is a payment usually made in the future. Hence the amount recorded as provision is usually the present value of all expenses which are expected to be incurred to settle the liability in the future. The discount rate to be used in calculating the present value of the obligation is usually the pre-tax interest rate.
RECORDING THE DECOMMISSIONING PROVISION (LIABILITY)
Usually, the liability is recorded with an offsetting increase in the asset. The provision or the liability is credited and the asset is debited. This means that the asset value is increased to the extent of the liability. Hence the accounting entry for recording the decommissioning provision would be as follows
Cr.Decommissioning Provision (liability)
SUBSEQUENT MEASUREMENT OF THE DECOMMISSIONING LIABILITY the decommissioning provision
After the initial recognition of the liability, the amount of provision is again changed if there is a change in the estimate and the estimate seems to be more reliable than the previous one.
The amount of provision is also changed if there is a change in the present value which is again caused by any changes in the discount rate or the time period.
In case if there is an increase in the present value, this increase is recognized as an interest expense and the offsetting entry would be to increase the provision. Here goes the accounting entry for recording the increase in the decommissioning liability subsequently.
Interest Expense Dr
Decommissioning Provisions Cr
SUBSEQUENT MEASUREMENT OF THE ASSET
The changes in the estimates or the number of years or the changes in discount rate will not affect the asset. The asset will be continued to be depreciated throughout its useful life. For example, if the mining operation will take place for 5 years initially and then the number of years are reduced to 4, the asset will still be depreciated as any other asset for 5 years.
Note: Here any changes in the present value estimate is shown as an interest only and it does not affect the asset value.
Are decommissioning costs capitalized?
Decommissioning costs are capitalized during their initial recognition.
What are decommissioning liabilities?
Decommissioning becomes a liability when there arises an obligation on the part of the entity to decommission the asset and restore the property or land to its original condition.
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