FR Question 2

Question Sea

Question 2 of 10

Question 2 : On 1 July 20X4, Experimenter opened a chemical reprocessing plant. The plant was due to be active for five years until 30 June 20X9, when it would be decommissioned. At 1 July 20X4, the costs of decommissioning the plant were estimated to be $4 million in 5 years’ time. Experimenter considers that a discount rate of 12% is appropriate for the calculation of a present value, and the discount factor at 12% for five years is 0.567.

What is the total charge to the statement of profit or loss in respect of the
decommissioning for the year ended 30 June 20X5?
A $453,600
B $725,760
C $800,000
D $2,268,000

The cost of the decommissioning is assumed to be an obligation for the entity. An amount
should be included in the cost of the asset when it is first recognised (1 July 20X4).
The amount to include in the cost of the asset for decommissioning costs is the present
value of the expected future decommissioning costs. The present value is calculated by
multiplying the expected future cost by a discount factor, which in this case is the discount
factor for Year 5 (20X9) at 12%. $4 million × 0.567 = $2.268 million.
Therefore:
Debit: Cost of asset $2.268 million
Credit: Provision for decommissioning costs $2.268 million
The asset is depreciated on a straight-line basis over five years.
In addition, the decommissioning cost should be increased to $4 million by the end of
Year 5. This is done by charging a finance cost each year. This is charged at the cost of
capital (12%) and applied to the balance on the provision account. The finance charge for
the year to 30 June 20X5 is 12% × $2.268 million = $272,160.
Debit: Finance cost $272,160
Credit: Provision for decommissioning costs $272,160

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