We will further investigate the interaction and interconnection among various standards related to the same transaction. Each standard affects the transaction from its own viewpoint.
Example
Assume Momma enter on 1/1/2019, into a 6 year lease contract with Elmor concerning a piece of land. Momma erects a plant on the leased piece of land, for a total cost of £ 200,000. They will use the plant to store material, equipment and other related elements, to be used for national road construction. As part of the agreement, Momma undertake the obligation to dismantle the plant at the end of the lease period. The estimated cost of dismantling is approximately £ 44,300. Discounted at Momma’s cost of capital of 4%, equals £ (44,300) / 1.04 ^ 6 = £ 35,010.
A legal obligation of uncertain timing or amount arises, which must be recognized as Momma has no realistic alternative but to settle it, at the end of the 6 year period, based on the best available estimate. No one can tell for sure if Momma will indeed use the plant for the full 10 year period, thus the time uncertainty. Likewise it is very likely that the amount may need to change, due to Momma’s re-estimation during the lease period, as to the exact amount that Momma will need to spend to dismantle the plant.
Still, Momma should apply professional judgment and recognize the provision at the inception of the lease contract. Assuming that no re-estimate occurs and that Momma dismantle the plant exactly 10 years from the lease commencement, the provision will need to be recognized as follows during the lease period.
| Year | Opening balance | Finance cost (4%) | Ending balance |
| 2019 | 35,010 | 1,400 | 36,410 |
| 2020 | 36,410 | 1,456 | 37,866 |
| 2021 | 37,866 | 1,515 | 39,381 |
| 2022 | 39,381 | 1,575 | 40,956 |
| 2023 | 40,956 | 1,638 | 42,594 |
| 2024 | 42,594 | 1,706 | 44,300 |
| Total | 9,290 |
Accounting entries of 2019
| Property, plant and equipment 235,000 | |
| Banks 200,000 | |
| Provision 35,000 |
| Finance cost 1,400 | |
| Provision 1,400 |
| Depreciation (235,000/6) 39,167 | |
| Accumulated depreciation 39,167 |
At the end of 2019, the net book value of the plant will be £ 195,833, and of the provision as per the schedule above, £ 36,410. Momma will need to ascertain at the end of 2019:
- The expected useful life of the plant, combining IAS 16 Property, Plant and Equipment, with IAS 8 Accounting Policies, Changes in Accounting Estimates, and Errors. Momma estimate the period during which they expect the benefits to flow into the entity. Any difference between the re-estimation and original period, will be applied prospectively. Assuming they conclude that the benefits will flow for another 8 and not 5 years, they will depreciate the remaining £ 195,833 in 8 years. The same would be done if they would conclude the remaining benefits will flow into Momma for another, say, 4 instead of 5 years, they would apply the revised remaining period, prospectively.
- Whether there are indications that the minimum benefits to flow into Momma from continuing use of the plant are less than £ 195,833, applying IAS 36 Impairment of Assets. If that is the caee, Momma will proceed with impairment loss recognition in the statement of profit or loss. Detailed examples of this treatment is beyond the scope of this article.
- If the present value of the provision is appropriate, applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets and IAS 8 . If a re-estimate must be made, this will also be applied prospectively. This is further explained below.
State of affairs at the end of 2021
Assuming no changes to the original estimates have occurred so far, Momma’s balances in its statement of financial position will be as follows:
- Plant: £ 235,000 / 6 x 3 =£ 117,500.
- Provision: £ 39,381.
Option 1, increase in provision
Momma applies a combination of IAS 37 and IAS 8 and re-estimates the future value of the necessary provision to be £ 52,000, resulting into a present value of £ (52,000 / 1.04 ^ 3) = £ 46,227. The difference is recognised as per the end of 2021 by posting an identical entry as the original one at the commencement of the lease, i.e.:
| Plant 6,846 | |
| Provision 6,846 |
The value of the plant is revised to £ (117,500 + 6,846) = £ 124,346 and obviously the value of the liability to £ 46,227. At the same time, as the value of the plant is increased, Momma applies IAS 36 in order to determine if the future benefits to flow into Momma from the continuing use of the plant are not anymore at least £ 117,500, but at least £ 124,636.
Assuming no further changes, the revised provision schedule will be as follows:
| Year | Opening balance | Finance cost | Ending balance |
| 2022 | 46,227 | 1,849 | 48,076 |
| 2023 | 48,076 | 1,924 | 50,000 |
| 2024 | 49,999 | 2,000 | 52,000 |
| Total | 5,773 |
The increased finance cost charges of 2022-2024 following the re-estimate, £ (1,575+1,638+1,706) = £ 5,773 vs. the original finance cost charges for the same period £ 4,919, is a reflection that the re-estimation of the provision (IAS 37) is applied prospectively as per the IAS 8 principles. The one-off increase in the provision of £ 6,846 is recognized as part of the plant carrying amount, as per IAS 16 principles.
Option 2, decrease in provision
Momma re-estimates the future value of the necessary provision to be £ 41,000, resulting into a present value of £ (41,000 / 1.04 ^ 3) = £ 36,449. The difference is recognised as per the end of 2021 by posting a reversed entry as the original one at the commencement of the lease, i.e.:
| Provision (39,381 – 36,449) = 2,932 | |
| Plant 2,932 |
Assuming no further changes, the revised provision schedule will be as follows:
| Year | Opening balance | Finance cost | Ending balance |
| 2022 | 36,449 | 1,458 | 37,907 |
| 2023 | 37,907 | 1,516 | 39,423 |
| 2024 | 39,423 | 1,577 | 41,000 |
| Total | 4,551 |
As in Option 1, the decreased charges of 2022-2024 following the re-estimate, £ (1,575+1,638+1,706) = £ 4551 vs. the original finance cost charges for the same period £ 4,919, is a reflection that the re-estimation of the provision (IAS 37) is applied prospectively as per the IAS 8 principles. The one-off decrease in the provision of £ 2,932 is decreased from the plant’s carrying amount, as per IAS 16 principles.
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