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ACCA Applied Skills · Financial Reporting · Provisions and events after the reporting period

Echo Co must pay to clean up contamination in three years' time. The expected cost at that date is $1,331,000, and the entity's appropriate pre-tax discount rate is 10%. The obligation arises at the start of the current year. What is the provision initially recognised, and what finance cost is recognised in the first year?

The provision is initially $1,000,000, being $1,331,000 discounted for three years at 10%. In the first year the discount unwinds, giving a finance cost of $100,000, which is 10% of the opening provision and is recognised in profit or loss.

  1. AProvision $1,000,000; finance cost $100,000Correct
  2. BProvision $1,331,000; finance cost nil
  3. CProvision $1,000,000; finance cost $133,100
  4. DProvision $1,210,000; finance cost $121,000

Explanation

IAS 37 requires discounting when the time value of money is material. $1,331,000 / 1.1^3 = $1,000,000. The unwinding in year one is 10% x $1,000,000 = $100,000, recognised as a finance cost. Using the undiscounted amount ignores time value, and $133,100 applies 10% to the future value.

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