A mining company operates a quarry. Under local legislation, it is legally required to restore the landscape once mining operations cease in 10 years. The estimated cost of restoration is $5 million. How should this be accounted for in the current year's financial statements?

Answer options:

Disclose it as a contingent liability in the notes to the financial statements.

Recognize a provision for $500,000 (being $5m divided by 10 years) in the current year.

Recognize a provision for the present value of the $5 million, and capitalize the same amount as part of the cost of the quarry asset.

Do nothing until the restoration work actually begins in 10 years.

How to approach this question

Apply IAS 37 (Provisions) and IAS 16 (PPE). A legal obligation exists, so a provision is needed. Because the obligation arises from acquiring/developing the asset, the cost is capitalized.

Full Answer

C.Recognize a provision for the present value of the $5 million, and capitalize the same amount as part of the cost of the quarry asset.✓ Correct

Because there is a legal obligation to restore the site, a provision must be recognized for the present value of the expected cost. Under IAS 16, the initial estimate of the costs of dismantling and removing the item and restoring the site is included in the cost of the property, plant, and equipment. The capitalized cost is then depreciated over the 10 years, and the provision is unwound (interest expense) over the same period.

Common mistakes

Thinking it should just be disclosed as a contingent liability, or expensing the full amount immediately.

Question 17 All questions Question 19

Practice the full ACCA FA — Financial Accounting Practice Exam 4

65 questions · hints · full answers · grading

More questions from this exam

Q01Global Water Initiative, an international NGO, receives a restricted grant of $500,000 specifical...Medium Q02MetroGrid Water, a public utility company, is preparing its annual financial statements. Which of...Easy Q03EuroTrade Logistics operates across multiple European borders. Which TWO of the following are pri...Medium Q04CloudSync Inc, a tech startup, is developing a new proprietary algorithm. The directors want to c...Medium Q05GreenHarvest Farms changes its depreciation method for tractors from straight-line to reducing ba...Medium

View all 65 questions →