Decommissioning costs

Installation of fixed assets requires sincere work and incurs certain charges called commissioning costs for setting up and making a modification to the landscape for erecting the asset.

Similarly, the decommissioning cost is the cost incurred by the companies to reverse modifications that were made in setting up in the landscape.

This means the asset is used up and set for sale or salvage. Decommissioning costs are also popularly called asset retirement costs.

In this article, we will discuss detail on how to account for decommissioning costs

Industries where decommissioning is done.

The asset heavy industries such as metal industries and oil and other companies requiring large asset to be set for manufacturing incurs decommissioning cost.

These costs are usually very high in oil industries due to the nature of functioning. They have to keep and put drilling instruction in use so as to not let harmful gases leakage to earth.

Standards for Decommissioning costs

Decommissioning costs may require a provision in certain industries as per the prudent approach. IAS 37 on Provisions, contingent liabilities, and Contingent Assets require the creation of provision.

Similarly, IAS 16 Property, Plant and Equipment require including the initial estimate of the costs of dismantling and removing the item and restoring the site into the cost of an asset.

Further, IFRS has developed IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities to account for such decommissioning costs.

Computation of decommissioning costs

Since, these costs are future costs and likely, time value concept loops into the computation of decommissioning costs. The following are the steps in the calculation of the cost:

  • Compute decommissioning present cost using the time value of the asset assuming no improvement in decommissioning procedure.
  • Take into account the expected inflation to the time of actual decommissioning of the asset.
  • Use the discount rate and compute decommissioning liabilities or provisions to be included in the cost of the asset.
  • Unwind the discount on decommissioning assets that equal the opening balance of the decommissioning obligation. This will result in the period end balance of decommissioning liability.
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Accounting treatment for decommissioning costs

 Initial Recognition and Measurement

The retirement of production assets may be required by operating licenses or past practices. As per IAS 37, this ought to create an obligation and thus a liability.

Further, a corresponding asset is created as per IAS 16 on Property, Plant, and Equipment, which defines cost as an initial estimate of dismantling and removing the asset and restoring the site on which it is located.

The required accounting treatment in this scenario would be

DateParticularsDebit ($)Credit ($)
 Property, Plant and equipmentXXX 
           Provisioning for decommission XXX

Such provisions are calculated by using present value concept

Subsequent Recognition and Measurement

When the asset is used up, unwind the discount and charge the interest on provisions to build up the required provisions over the life of the asset. This discount has to be recognized as a finance cost in the income statement.

DateParticularsDebit ($)Credit ($)
 Finance costsXXX 
           Provisioning for decommission XXX

Further, this cost of provision has to be depreciated over the useful life of fixed asset.

If changes to provision relate to removal of asset, then there is the case of decrease in value of asset as:

DateParticularsDebit ($)Credit ($)
 Provisioning for decommissionXXX 
           Property, Plant and Equipment          XXX

However, the asset cannot go below zero and neither can go above its recoverable amount . If the decrease in provision exceeds the carrying amount of the asset, the excess is recognized immediately in profit or loss.

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At the end of useful life of asset, the company decommissions the asset and restores the site to required condition and all the expenses are charged against the provision. The entry to be made here is :

DateParticularsDebit ($)Credit ($)
 Provisioning for decommissionXXX 
           Cash XXX