Rowsl proud various ethical policies towards its employees and the wider commu i
ID: 2590700 • Letter: R
Question
Rowsl proud various ethical policies towards its employees and the wider commu in which it operates. As part of its annual financial statements, the ey is a company that carries out many different activities of its reputation as a caring, organisation and has adopt company publishes details of its environmental policies, which include setting performance targets for activities such as recycling, contro emissions of noxious substances and limiting use of non-renewable resources. The company has an overseas operation that is involved in mining precious metals. These activities cause significant damage to the environment, including deforestation. The company incurred capital costs of $100 million in respect of the mine and it is expected that the mine will be abandoned in eight years' time. The mine is situated in a country where there is no environmental legislation obliging companies to rectify environmental damage and it is very unlikely that any such legislation will be enacted within the next eight years. It has been estimated that the cost of cleaning the site and re-planting the trees wi be $25 million if the replanting were successful at the first attempt, butit will probably be necessary to make a further attempt, which will increase the cost by a further $5 million. The company's cost of capital is 10%. Should a provision for the cost of cleaning the site be made and prepare extracts of the financial statements?Explanation / Answer
Solution :
The above question pertains to Asset Retirement Obligations.
An asset retirement obligation (ARO) is a liability associated with the eventual retirement of a fixed asset. The liability is commonly a legal requirement to return a site to its previous condition. A business should recognize the fair value of an ARO when it incurs the liability and if it can make a reasonable estimate of the fair value of the ARO.
In this case, we do have an estimated cost of cleaning the site at the end of eight years $ 25 million and another $5 million . As per the principle of conservatism once a liability is certain to be occured in future , a provision has to be made in the books of accounts.
Recognizing this liability as soon as possible gives the readers of a company's financial statements a better grasp of the true state of its obligations, especially since ARO liabilities can be quite large.
Recognition Amount :
The provision must be made based upon the present value of future cash flows. SInce the cost of capital is 10% we can find out the present value of future cash flows using the discounting method and recognise the liability in the books.
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