Basis for Conclusions on IFRIC 1 (INT1_07-15_COMPfeb16_01-19)

This Basis for Conclusions summarises the IFRIC’s considerations in reaching its consensus. Individual IFRIC members gave greater weight to some factors than to others.

IAS 16 Property, Plant and Equipment requires the cost of an item of property, plant and equipment to include the initial estimate of the costs of dismantling and removing an asset and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that the measurement of the liability, both initially and subsequently, should be the estimated expenditure required to settle the present obligation at the balance sheet date end of the reporting period and should reflect a current market-based discount rate. It requires provisions to be reviewed at each balance sheet date the end of each reporting period and adjusted to reflect the current best estimate. Hence, when the effect of a change in estimated outflows of resources embodying economic benefits and/or the discount rate is material, that change should be recognised.

The IFRIC was asked to address how to account for changes in decommissioning, restoration and similar liabilities. The issue is whether changes in the liability should be recognised in current period profit or loss, or added to (or deducted from) the cost of the related asset. IAS 16 contains requirements for the initial capitalisation of decommissioning costs and IAS 37 contains requirements for measuring the resulting liability; neither specifically addresses accounting for the effect of changes in the liability. The IFRIC was informed that differing views exist, resulting in a risk of divergent practices developing.

Accordingly, the IFRIC decided to develop guidance on accounting for the changes. In so doing, the IFRIC recognised that the estimation of the liability is inherently subjective, since its settlement may be very far in the future and estimating (a) the timing and amount of the outflow of resources embodying economic benefits (eg cash flows) required to settle the obligation and (b) the discount rate often involves the exercise of considerable judgement. Hence, it is likely that revisions to the initial estimate will be made.

The scope of the Interpretation addresses the accounting for changes in estimates of existing liabilities to dismantle, remove and restore items of property, plant and equipment that fall within the scope of IAS 16 and are recognised as a provision under IAS 37. The Interpretation does not apply to changes in estimated liabilities in respect of costs that fall within the scope of other IFRSs, for example, inventory or production costs that fall within the scope of IAS 2 Inventories. The IFRIC noted that decommissioning obligations associated with the extraction of minerals are a cost either of the property, plant and equipment used to extract them, in which case they are within the scope of IAS 16 and the Interpretation, or of the inventory produced, which should be accounted for under IAS 2.

The IFRIC reached a consensus that changes in an existing decommissioning, restoration or similar liability that result from changes in the estimated timing or amount of the outflow of resources embodying economic benefits required to settle the obligation, or a change in the discount rate, should be added to or deducted from the cost of the related asset and depreciated prospectively over its useful life.

In developing its consensus, the IFRIC also considered the following three alternative approaches for accounting for changes in the outflow of resources embodying economic benefits and changes in the discount rate:

(a)            capitalising only the effect of a change in the outflow of resources embodying economic benefits that relate to future periods, and recognising in current period profit or loss all of the effect of a change in the discount rate.

(b)            recognising in current period profit or loss the effect of all changes in both the outflow of resources embodying economic benefits and the discount rate.

(c)            treating changes in an estimated decommissioning, restoration and similar liability as revisions to the initial liability and the cost of the asset. Under this approach, amounts relating to the depreciation of the asset that would have been recognised to date would be reflected in current period profit or loss and amounts relating to future depreciation would be capitalised.

The IFRIC rejected alternative (a), because this approach does not treat changes in the outflow of resources embodying economic benefits and in the discount rate in the same way, which the IFRIC agreed is important, given that matters such as inflation can affect both the outflow of economic benefits and the discount rate.

In considering alternative (b), the IFRIC observed that recognising all of the change in the discount rate in current period profit or loss correctly treats a change in the discount rate as an event of the present period. However, the IFRIC decided against alternative (b) because recognising changes in the estimated outflow of resources embodying economic benefits in current period profit or loss would be inconsistent with the initial capitalisation of decommissioning costs under IAS 16.

Alternative (c) was the approach proposed in draft Interpretation D2 Changes in Decommissioning, Restoration and Similar Liabilities, published on 4 September 2003. In making that proposal, the IFRIC regarded the asset, from the time the liability for decommissioning is first incurred until the end of the asset’s useful life, as the unit of account to which decommissioning costs relate. It therefore took the view that revisions to the estimates of those costs, whether through revisions to estimated outflows of resources embodying economic benefits or revisions to the discount rate, ought to be accounted for in the same manner as the initial estimated cost. The IFRIC still sees merit in this proposal, but concluded on balance that, under current standards, full prospective capitalisation should be required for the reasons set out in paragraphs BC12–BC18.

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors requires an entity to recognise a change in an accounting estimate prospectively by including it in profit or loss in the period of the change, if the change affects that period only, or the period of the change and future periods, if the change affects both. To the extent that a change in an accounting estimate gives rise to changes in assets or liabilities, or relates to an item of equity, it is required to be recognised by adjusting the asset, liability or equity item in the period of change.

Although the IFRIC took the view that the partly retrospective treatment proposed in D2 is consistent with these requirements of IAS 8, most responses to the draft Interpretation suggested that IAS 8 would usually be interpreted as requiring a fully prospective treatment. The IFRIC agreed that IAS 8 would support a fully prospective treatment also, and this is what the Interpretation requires.

Many responses to the draft Interpretation argued that the proposal in D2 was inconsistent with IAS 16, which requires other kinds of change in estimate for property, plant and equipment to be dealt with prospectively. For example, as IAS 8 also acknowledges, a change in the estimated useful life of, or the expected pattern of consumption of the future economic benefits embodied in, a depreciable asset affects depreciation expense for the current period and for each future period during the asset’s remaining useful life. In both cases, the effect of the change relating to the current period is recognised in profit or loss in the current period. The effect, if any, on future periods is recognised in profit or loss in those future periods.

Some responses to the draft Interpretation noted that a change in the estimate of a residual value is accounted for prospectively and does not require a catch-up adjustment. They observed that liabilities relating to decommissioning costs can be regarded as negative residual values, and suggested that the Interpretation should not introduce inconsistent treatment for similar events. Anomalies could result if two aspects of the same change are dealt with differently—for example, if the useful life of an asset was extended and the present value of the decommissioning liability reduced as a result.

The IFRIC agreed that it had not made a sufficient case for treating changes in estimates of decommissioning and similar liabilities differently from other changes in estimates for property, plant and equipment. The IFRIC understood that there was no likelihood of the treatment of other changes in estimate for such assets being revisited in the near future.

The IFRIC also noted that the anomalies that could result from its original proposal, if other changes in estimate were dealt with prospectively, were more serious than it had understood previously, and that a fully prospective treatment would be easier to apply consistently.

The IFRIC had been concerned that a fully prospective treatment could result in either unrealistically large assets or negative assets, particularly if there are large changes in estimates toward the end of an asset’s life. The IFRIC noted that the first concern could be dealt with if the assets were reviewed for impairment in accordance with IAS 36 Impairment of Assets, and that a zero asset floor could be applied to ensure that an asset did not become negative if cost estimates reduced significantly towards the end of its life. The credit would first be applied to write the carrying amount of the asset down to nil and then any residual credit adjustment would be recognised in profit or loss. These safeguards are included in the final consensus.

In reaching its consensus, the IFRIC considered the US GAAP approach in Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (SFAS 143). Under that standard, changes in estimated cash flows are capitalised as part of the cost of the asset and depreciated prospectively, but the decommissioning obligation is not required to be revised to reflect the effect of a change in the current market-assessed discount rate.

The treatment of changes in estimated cash flows required by this Interpretation is consistent with US GAAP, which the proposal in D2 was not. However, the IFRIC agreed that because IAS 37 requires a decommissioning obligation to reflect the effect of a change in the current market-based discount rate (see paragraph BC3), it was not possible to disregard changes in the discount rate. Furthermore, SFAS 143 did not treat changes in cash flows and discount rates in the same way, which the IFRIC had agreed was important.

In developing the Interpretation, the IFRIC considered the improvements that have been made to IAS 16 by the Board and agreed that it would explain the interaction of the two.

IAS 16 (as revised in 2003) clarifies that the initial measurement of the cost of an item of property, plant and equipment should include the cost of dismantling and removing the item and restoring the site on which it is located, if this obligation is incurred either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. This is because the Board concluded that whether the obligation is incurred upon acquisition of the item or as a consequence of using it, the underlying nature of the cost and its association with the asset are the same.

However, in considering the improvements to IAS 16, the Board did not address how an entity would account for (a) changes in the amount of the initial estimate of a recognised obligation, (b) the effects of accretion of, or changes in interest rates on, a recognised obligation or (c) the cost of obligations that did not exist when the entity acquired the item, such as an obligation triggered by a change in a law enacted after the asset is acquired. The Interpretation addresses issues (a) and (b).

IAS 16 allows an entity to choose either the cost model or the revaluation model for measuring its property, plant and equipment, on a class-by-class basis. The IFRIC’s view is that the measurement model that an entity chooses under IAS 16 would not be affected by the Interpretation.

Several responses to the draft Interpretation sought clarification of how it should be applied to revalued assets. The IFRIC noted that:

(a)            if the entity chooses the revaluation model, IAS 16 requires the valuation to be kept sufficiently up to date that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.^[3]  This Interpretation requires a change in a recognised decommissioning, restoration or similar liability generally to be added to or deducted from the cost of the asset. However, a change in the liability does not, of itself, affect the valuation of the asset for financial reporting purposes, because (to ensure that it is not counted twice) the separately recognised liability is excluded from its valuation.

(b)            rather than changing the valuation of the asset, a change in the liability affects the difference between what would have been reported for the asset under the cost model, under this Interpretation, and its valuation. In other words, it changes the revaluation surplus or deficit that has previously been recognised for the asset. For example, if the liability increases by CU20, which under the cost model would have been added to the cost of the asset, the revaluation surplus reduces (or the revaluation deficit increases) by CU20. Under the revaluation model set out in IAS 16, cumulative revaluation surpluses for an asset are accounted for in equity,^[4] and cumulative revaluation deficits are accounted for in profit or loss. The IFRIC decided that changes in the liability relating to a revalued asset should be accounted for in the same way as other changes in revaluation surpluses and deficits under IAS 16.^[5]

(c)            although a change in the liability does not directly affect the value of the asset for financial reporting purposes, many events that change the value of the liability may also affect the value of the asset, by either a greater or lesser amount. The IFRIC therefore decided that, for revalued assets, a change in a decommissioning liability indicates that a revaluation may be required. Any such revaluation should be taken into account in determining the amount taken to profit or loss under (b) above. If a revaluation is done, IAS 16 requires all assets of the same class to be revalued.

(d)            the depreciated cost of an asset (less any impairment) should not be negative, regardless of the valuation model, and the revaluation surplus on an asset should not exceed its value. The IFRIC therefore decided that, if the reduction in a liability exceeds the carrying amount that would have been recognised had the asset been carried under the cost model, the excess reduction should always be taken to profit or loss. For example, if the depreciated cost of an unimpaired asset is CU25, and its revalued amount is CU100, there is a revaluation surplus of CU75. If the decommissioning liability associated with the asset is reduced by CU30, the depreciated cost of the asset should be reduced to nil, the revaluation surplus should be increased to CU100 (which equals the value of the asset), and the remaining CU5 of the reduction in the liability should be taken to profit or loss.^[6]

The IFRIC considered whether the unwinding of the discount is a borrowing cost for the purposes of IAS 23 Borrowing Costs. This question arises because if the unwinding of the discount rate were deemed a borrowing cost for the purposes of IAS 23, in certain circumstances this amount might be capitalised under the allowed alternative treatment of capitalisation.^[7]  The IFRIC noted that IAS 23 addresses funds borrowed specifically for the purpose of obtaining a particular asset. It agreed that a decommissioning liability does not fall within this description since it does not reflect funds (ie cash) borrowed. Hence, the IFRIC concluded that the unwinding of the discount is not a borrowing cost as defined in IAS 23.

The IFRIC agreed that the unwinding of the discount as referred to in paragraph 60 of IAS 37 should be reported in profit or loss in the period it occurs.

The IFRIC considered whether the Interpretation should include disclosure guidance and agreed that it was largely unnecessary because IAS 16 and IAS 37 contain relevant guidance, for example:

(a)            IAS 16 explains that IAS 8 requires the disclosure of the nature and effect of changes in accounting estimates that have an effect in the current period or are expected to have a material effect in subsequent periods, and that such disclosure may arise from changes in the estimated costs of dismantling, removing or restoring items of property, plant and equipment.

(b)            IAS 37 requires the disclosure of:

(i)             a reconciliation of the movements in the carrying amount of the provision for the period.

(ii)            the increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate.

(iii)           a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits.

(iv)           an indication of the uncertainties about the amount or timing of those outflows, and where necessary the disclosure of the major assumptions made concerning future events (eg future interest rates, future changes in salaries, and future changes in prices).

However, in respect of assets measured using the revaluation model, the IFRIC noted that changes in the liability would often be taken to the revaluation surplus. These changes reflect an event of significance to users, and the IFRIC agreed that they should be given prominence by being separately disclosed and described as such in the statement of changes in equity.^[8]

The IFRIC agreed that preparers that already apply IFRSs should apply the Interpretation in the manner required by IAS 8, which is usually retrospectively. The IFRIC could not justify another application method, especially when IAS 37 requires retrospective application.

The IFRIC noted that, in order to apply the Interpretation retrospectively, it is necessary to determine both the timing and amount of any changes that would have been required by the Interpretation. However, IAS 8 specifies that:

(a)            if retrospective application is not practicable for all periods presented, the new accounting policy shall be applied retrospectively from the earliest practicable date; and

(b)            if it is impracticable to determine the cumulative effect of applying the new accounting policy at the start of the current period, the policy shall be applied prospectively from the earliest date practicable.

The IFRIC noted that IAS 8 defines a requirement as impracticable when an entity cannot apply it after making every reasonable effort to do so, and gives guidance on when this is so.

However, the provisions of IAS 8 on practicability do not apply to IFRS 1 First-time Adoption of International Financial Reporting Standards. Retrospective application of this Interpretation at the date of transition to IFRSs, which is the treatment required by IFRS 1 in the absence of any exemptions, would require first-time adopters to construct a historical record of all such adjustments that would have been made in the past. In many cases this will not be practicable. The IFRIC agreed that, as an alternative to retrospective application, an entity should be permitted to include in the depreciated cost of the asset at the date of transition an amount calculated by discounting the liability at that date back to, and depreciating it from, when it was first incurred. This Interpretation amends IFRS 1 accordingly.