Where IAS 16 Property, Plant & Equipment , IAS 36 Impairment of Assets meet
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, and IAS 37 Provisions, Contingent Liabilities, Contingent Assets, Part 1.
Chris Ragkavas, BA, MA, FCCA, CGMA
IFRS technical expert, financial consultant.
Owners entering into lease contracts, often require lessees to undertake as per the commencement of a transaction, the obligation to return the non-current asset leased at its original state. Think of a site used by the lessee for rendering road construction services, or a site used for extraction purposes by the lessee.
Lessees would need to erect a plant on the site to be used for their business purposes, during the contract.
Owners (lessors) may require at the inception of the contract that the lessee undertakes the obligation to dismantle/decommission the construction plant erected by the lessee, and return the site at its original condition.
Below issues determine the accounting treatment and the commensurate financial reporting implications. These are:
By entering into a contract that includes a clause that the lessee is responsible for dismantling the plant, a legal obligation exists to do so. A liability, i.e. a provision must be recognized at the inception of the contract.
This obligation will -in all likelihood- be settled in the distant future. The commensurate amount will be discounted. In subsequent accounting periods, this discount will be unwound as finance cost.
As it is impossible to know with absolute certainty, at the commencement of the lease, how much the dismantling will cost, any accounting will be based on the best available estimate.
The economic benefits to be derived from the erected plant during its expected useful life, are inseparable from the obligation to decommission the facility. The debit side of the provision journal will be therefore, a non-current asset.
The logic of the accounting treatment is therefore that as a present legal obligation exists, a liability is recognized and that the benefits to be derived from using the facility to be dismantled are inseparable from this obligation.
In subsequent periods, the non-current asset is, subject to depreciation and impairment testing based on the IAS 36 Impairment of assets.
In subsequent periods, the provision is subject to increase by charging finance costs and to re-estimation, which is applied prospectively.
More on these subjects, on Part 2 (and final).
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