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ACCA Applied Knowledge · Financial Accounting · Provisions and contingencies

Orwell Co operates an offshore oil platform. At 31 December 20X5 it is legally required to remove the platform at the end of its life, which is 10 years away. The estimated removal cost then is $5,000,000, and the present value of this at the appropriate discount rate is $3,100,000. The platform was installed in 20X5 and the obligation arose on installation. Which entry should be made on initial recognition at 31 December 20X5?

Debit the platform and credit the provision with the present value of $3,100,000. The installation creates a present legal obligation, the time value is material so the amount is discounted, and the decommissioning cost forms part of the asset's cost, with discount unwinding later charged as finance cost.

  1. ADr Statement of profit or loss $5,000,000; Cr Provision $5,000,000
  2. BDr Non-current assets (platform) $3,100,000; Cr Provision $3,100,000Correct
  3. CDr Non-current assets (platform) $5,000,000; Cr Provision $5,000,000
  4. DNo entry until the platform is removed

Explanation

The obligating event is the installation, so a present legal obligation exists and a provision is required. Because the effect of time is material, the provision is measured at present value, $3,100,000. The cost is capitalised as part of the asset's cost, since it gives access to future economic benefits, rather than expensed. The unwinding of the discount is later charged as a finance cost.

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