Question

d) An entity is about to begin to operate a coal mine. At the end of the reporting period, the mineshaft has been prepared and all the necessary equipment has been constructed and is in place, but no coal has yet been extracted. Under local law, the entity is obliged to rectify all damage to the site once the mining operation has been completed (this is expected to be several years from now). Management estimates that 20% of the eventual costs of performing this work will relate to removing the equipment and various buildings and the remaining 80% will relate to restoring the damage caused by the actual extraction of coal.

Required Should a provision be recognised for the cost of restoring the damage?      [5 marks]

Answer 1

Yes, a provision should be recognised for the cost of restoring the damage. The provision is only required on the 80% costs relating to the restoring of the damages as these are obligation towards the government and will be incurred 100% in future. The rest 20% is not an obligation and should be expensed in the year of actual expense, thus no provision is required. Now we should determine the amount at which the provision is to be initially recognised. The damage should be initially recognised at present value of the future cash flow, that is the business should estimate the actual cash outflow expected to be made on the site, this amount should be multiplied by the discounting factor to determine the present value of this cash outflow.