Accounting for decommissioning, restoration and similar provisions to make good (RMG 114)

AASB 137 paragraph 14 requires provisions (make good obligations) to be recognised where:

• there is a present obligation (legal or constructive) that has arisen from a past event
• there is a probable outflow of resources
• the eventual payment amount can be reliably estimated.

Present value

Under paragraphs 36-52 of AASB 137, the initial measurement of the provision should be the best estimate of expenditure needed to settle the present obligation at the end of the financial reporting period.

AASB 137 paragraph 45 stipulates where the TVOM is material, the provision should be discounted to reflect the present value of the estimated expenditures. Where the TVOM is not material, discounting is not required.

Selecting discount rates for present value calculations

Extract: AASB 137 

To reflect the risks appropriately, entities need to carefully consider the discount rate applicable to all provisions, including for make good. Discount rates for make good provisions:

• should not simply be the discount rates that apply to other provisions (for example, a risk free or government bond rate may only be applicable if all other risks have been factored into the cash flow estimates)
• should not reflect risks for which, future cash flow estimates have been adjusted as this would double-count risk calculations.

Estimating the expenditure required to settle the obligation

A common method of estimating the future expenditure required to settle the obligation is to:

• obtain a reasonable ‘at present’ estimate of the expenditure required to make good the asset (for example, with quotes based on past experience in similar situations), then
• adjust the estimate, using inflationary measures such as the Consumer Price Index or building price indices, to derive expenditure required in a future reporting period.

An example showing the process for estimating the expenditure required to settle the present obligation at the reporting date, is included at Appendix A - IE1.

Make good provisions capitalised

On initial recognition, make good provisions should be capitalised to the related asset. Under paragraph 16 of AASB 116, the cost of an item of PPE includes the:

• purchase price, including duties and taxes
• directly attributable costs (see the examples at paragraph 17 of AASB 116)
• initial estimate of make good costs.

Under paragraph 24 of AASB 16, the cost of a leased right-of-use (ROU) asset includes:

• the initial measurement of the lease liability
• lease payments made at or before the commencement date, less any lease incentives received
• initial direct costs
• estimated make good costs.

Where a lessee’s make good obligations arise from normal wear and tear on the leased asset, the make good provision should be capitalised to the ROU asset. For example, if the lease contract requires the lessee to repaint the premises or service the air conditioning and lift systems at lease end, the lessee’s make good provision should be capitalised to the ROU asset.

However, where make good obligations relate to lessee’s leasehold improvements, the make good provision should be capitalised to those leasehold improvements – not the ROU asset. For example, when a lessee is required to remove office partitions and other office configuration works at the end of the lease term, the make good provision would be capitalised to the relevant leasehold improvement asset.

The Central Budget Management System (CBMS) account details, for the initial recognition of a make good provision capitalised to leasehold improvements, are:

CBMS journal entries: Initial recognition of make good provision capitalised to leasehold improvements

_{^{*     Movement (Mmt) code}}

_{^{^     Even though the above journal entry does not separate the make good component of the asset, entities may find it useful to show this separately in the asset register/ledger. This will assist entities when applying revaluations and impairment requirements on the assets.}}

Unwinding of the discount

As per paragraph 45 of AASB 137, where the TVOM is material, the make good provision should be discounted to reflect the present value of the estimated expenditures.

The unwinding of the discount effectively increases the make good provision each year, to reflect the passage of time – where the TVOM is material, the periodic unwinding of the discount:

• increases the make good provision
• is recognised in the operating statement as a finance cost (capitalisation of this cost is disallowed under paragraph 8 of AASB Interpretation 1).

The unwinding of the provision should be recognised before revising the provision for any estimate changes.

Example 1: Unwinding of the make good provision

Using the scenario at illustrative example (IE) 1, where:

• $50,000 is to be paid in five years (that is, in 20X5) to make good a premises
• a 10% discount rate applies.

The unwinding of the provision is shown below.

Changes in make good provision estimates

Changes in estimates must be accounted for in accordance with AASB Interpretation 1. Changes in estimates may result from a change in the:

• estimated timing of payments on settlement
• estimated amount that will eventually be required to settle the obligation, or
• discount rate.

Under paragraph 59 of AASB 137, entities are to review the make good provision at each reporting date and make adjustments to reflect the current best estimate. Where it is no longer probable that the entity will be required to settle the obligation, the make good provision should be reversed.

Example 2: Re-measurement of the make good provision for changes in estimated payment timing

Using the scenario at IE1, if at the end of the lease term the entity extends the lease and does not make good the property at that time:

• the entity would be required to remeasure the provision to reflect this delay (rather than derecognise the provision)
• the adjustment to the provision would be recognised in the operating statement (as the related leasehold improvement asset is fully depreciated).

As per AASB Interpretation 1 accounting for these changes depends on whether the related asset is measured:

• under the cost model (Interpretation 1 paragraph 5), or
• at fair value under the revaluation model (Interpretation 1 paragraph 6).

The cost model

Under paragraph 24 of AASB 16, make good provisions may be included in the initial recognition of assets, including lease ROU assets. This would occur for leases that commenced after the AASB 16 transition date of 1 July 2019, where the make good obligation does not relate to leasehold improvements undertaken by the lessee.

Public Governance, Performance and Accountability (Financial Reporting) Rule 2015 (FRR) section 17 (2A) requires ROU assets to be measured at cost. For such assets accounting for changes in make good estimates is covered by AASB Interpretation 1 paragraph 5:

• increases in the make good provision due to revised estimates should be added to the cost of the related ROU asset
• decreases in the make good provision due to revised estimates should be deducted from the cost of the ROU asset. However, the amount of the reduction should not exceed the carrying amount of the ROU asset, with any excess recognised as a gain.

Example 3: Example of accounting for decreases in the make good provision

For this example:

• an entity revised its estimate of the make good provision downwards by $75,000
• the related ROU asset initially cost $600,000
• the related ROU asset has accumulated depreciation of $550,000.

In accounting for this example, as the deduction amount ($75,000) exceeds the carrying amount of the asset ($50,000), the entity deducts $50,000 from the ROU asset and the excess of $25,000 is recognised as a gain.

An increase in the cost of the ROU asset may indicate that the asset is not fully recoverable – where this occurs, consider testing for impairment under AASB 136 Impairment of Assets.

Where the related PPE asset is at the end of its useful life, all subsequent changes to make good provisions are recognised in the operating statement as they occur.

CBMS journal entries: Increase in make good provision where asset is measured at cost

CBMS journal entries: Decrease in make good provision where asset is measured at cost

For more information on decreases of a make good provision under the cost model, see Example 1: Cost model at paragraph IE2 of AASB Interpretation 1.

The revaluation model

PPE assets may be measured at fair value under AASB 116, including leasehold improvement assets to which make good costs have been capitalised. This is the default option for PPE under FRR section 17 (2).

Entities should identify whether an allowance for make good has been included or excluded in the asset valuation. For more information on the importance of understanding the basis of the valuation, see Example 2: Revaluation model at paragraph IE6 of AASB Interpretation 1.

General accounting for revaluations

To understand the accounting for changes in make good provisions under the revaluation model, entities should first understand the general treatment of asset revaluations.

For not-for-profit entities, for:

• a revaluation increase in the carrying amount of a class of PPE assets must be credited to the ARR (or recognised as a gain to the extent the revaluation increase reverses a decrease for the same class of PPE assets previously recognised as an expense)

CBMS journal entries: Revaluation increase in a PPE asset class

^{*     Where previous revaluation decrements have been recognised in the operating statement for that asset class.}

^{^     Movement code depends on the PPE asset class.}

• a revaluation decrease in the carrying amount of a class of PPE assets will be recognised as an expense (or debited directly to the ARR to the extent a credit balance exists in the ARR in respect of that class of assets).

CBMS journal entries: Revaluation decrease in a PPE asset class

^{*     For an existing balance in the ARR for that asset class, the movement code depends on the PPE asset class.}

Changes in make good provision estimates under the revaluation model

Changes in make good provision estimates (excluding provisions created after acquisition of the asset) under the revaluation model are the reverse of revaluations of the related asset – except for the account affected (asset or provision). Therefore:

• increases in the make good provision are recognised as an expense, except to the extent of any credit balance in the ARR for that asset class in which case the ARR is debited (similar to a revaluation decrease of an asset)
• decreases in the make good provision are credited to the ARR, except to the extent that the decrease reverses a revaluation decrease for that asset class previously recognised as an expense, in which case the decrease in the provision is credited as a gain (similar to a revaluation increase of an asset). Where the decrease in the provision exceeds the carrying amount of the asset that would have been recognised under the cost model, the excess is recognised as a gain.

For the provisions created after acquisition of the asset, further consideration should be given to the appropriate treatment.

Where the related PPE asset is at the end of its useful life, all subsequent changes to make good provisions are recognised in the operating statement as they occur.

A change in the provision may also indicate that the related asset should be revalued. If a revaluation is necessary, all assets of that class may need to be revalued in line with AASB 116 paragraph 36. Where assets of that class are regularly revalued on an ongoing or cyclical basis a revaluation of whole class is unlikely to be needed, since the value of assets of that class will be approximate value already.

These revaluations are taken into account in determining the amounts to be recognised in the operating statement or other comprehensive income (OCI).

CBMS journal entries: Increase in make good provision under revaluation model

^{*   For an existing balance in the ARR in respect of the asset class, the movement code depends on the PPE asset class.}

^{^   Movement code description is Net asset reval (Inc)/Dec-Provision for restoration, decommissioning and makegood.}

CBMS journal entries: Decrease in make good provision under revaluation model

^{^     Movement code depends on the PPE asset class.}

^{#     Movement code description is Net asset reval (Inc)/Dec-Provision for restoration, decommissioning and makegood.}

Derecognising provisions

If on settlement of obligation the full make good provision was not derecognised, a provision reversal should be recognised as a gain in the operating statement.

Make good provisions are a separate class of provisions that are to be disclosed in accordance with the requirements of AASB 137.

Under paragraph 84 of AASB 137, a movement schedule is required for the current year only. No comparative information is needed.

Under paragraph 85 of AASB 101 Presentation of Financial Statements, the changes in the ARR resulting from changes in make good provisions may be a separate OCI line item – where it is considered relevant to understanding an entity’s financial performance.

Accounting for provisions may require significant judgement and entities need to have sufficient documentation to support accounting treatments.

The impact on budget aggregates of transactions at different stages in the lifecycle of a make good provision are shown in the following table.

Impact on budget aggregates in the lifecycle of a make good provision

Related resources including appendices, glossary terms and relevant sections of the PGPA Act and Rule are located in the right-hand menu. This guide is to be read in conjunction with relevant accounting standards and interpretations issues by the Australian Accounting Standards Board (AASB) found under Tools and templates.

Appendix A - Illustrative examples

• This appendix provides Illustrating examples (IEs) on estimating expected expenditure. These examples also show the accounting treatment for a make good provision, including the initial recognition and subsequent change in provision estimates. The appendix is available under Tools and templates.
• Includes an example of showing the process for estimating the expenditure required to settle the present obligation at the reporting date.

Appendix B - Flowchart of accounting for changes in make good provision estimates

• This appendix provides a flowchart of the accounting for changes in make good provision estimates. This appendix is available under Tools and templates.

Appendix C - Glossary & Acronyms

• This appendix includes defined subject to key terms, all other key terms have the same definition as specified in the AASB Glossary of defined terms and all the acronyms for the full title/terms referenced above in this guide. This appendix is available under Tools and templates.