Appendix A – Illustrative Examples

The following Illustrative Examples (IEs) show the accounting treatment for a make good provision, including the initial recognition and subsequent change in provision estimates, where the provision is:

• for leasehold improvements – where the make good provision is accounted for as a component of the leasehold improvement asset and measured at fair value, see:
  • IE1: Make good provision capitalised to lessee leasehold improvements
  • IE2: Increase in provision capitalised to leasehold improvements held at fair value, due to revised estimates.

These IEs would also be applicable for any other make good provisions relating to PPE assets measured at fair value.

• for a lease commencing after the AASB 16 transition date – for a lease that commenced after 1 July 2019, where the make good provision does not relate to leasehold improvements by the lessee and is capitalised as a component of the lease ROU asset, measured at cost (under paragraph 24(d) of AASB 16), see:
  • IE3: Initial make good provision capitalised to a ROU asset
  • IE4: Increase in provision capitalised to a ROU asset held at cost.

Scenario: On 1 July 20X0, an entity entered into a 5 year lease for an office block and made $200,000 worth of leasehold improvements (capitalised as an asset by lessee). The contract specifies that the entity must make good any leasehold improvements on the premises at the end of the lease term. For this scenario:

• the leasehold improvements asset will include an estimate of the cost of making good the premises at the end of the lease and the entity estimated that, at 1 July 20X0, it would cost approximately $40,000 to return the building to its original condition
• assume the entity depreciates PPE on a straight-line basis, a discount rate of 10% applies and inflation is estimated at 4.5% per annum.

Accounting treatment

Initial accounting

To determine the expenditure required at the end of the lease (at 30 June 20X5), the entity projects the current value of the $40,000 using an inflationary measure of 4.5% as follows:

Future value (FV)                 = Present value x (1 + inflation rate) ^{Time period}
                                             = $40,000 x (1.045)⁵               = $50,000

As the TVOM is material, the $50,000 provision is discounted to its present value (PV). The following formula shows the process applied in calculating the PV:

Present value (PV)               = FV / (1 + discount rate) ^{Time period remaining}
                                             = $50,000 / (1.10)⁵                 = $31,046

At 1 July 20X0, the following journal is posted to recognise the leasehold improvement asset and the associated make good provision:

CBMS journal entries: Recognition of leasehold improvement asset and make good provision

Dr/Cr	CBMS account	Mmt Code	CBMS account description	Amount ($)
Dr	5311002	7121	Buildings - Leasehold improvements (asset)	231,046
Cr	5220000		Cash	200,000
Cr	3381008		Provisions for restoration, decommissioning and make good	31,046

 

Subsequent accounting

Over the life of the lease term, the discount on the make good provision is unwound to the full $50,000.

CBMS journal entries: Unwinding of the make good provision discount

Dr/Cr	CBMS Account	CBMS account description	30/06/X1 $	30/06/X2 $	30/06/X3 $	30/06/X4 $	30/06/X5 $
Dr	2422008	Unwinding of discount on restoration (expense)	3,105	3,415	3,756	4,133	4,545
Cr	3381008	Provisions for restoration, decommissioning and make good	3,105	3,415	3,756	4,133	4,545

 

The entity will also recognise depreciation expense for years 1 to 5, in relation to the related leasehold improvement asset, which is depreciated on a straight-line basis over the term of the lease of 5 years.

CBMS journal entries: Depreciation of leasehold improvement asset (30 June 20X1 – 20X5)

Dr/Cr	CBMS account	Mmt Code	CBMS account description	Amount ($)
Dr	2241002		Buildings - Depreciation (leasehold improvements)	46,209
Cr	5311002	7153	Buildings - Accumulated depreciation (leasehold improvements)	46,209

 

At the end of the lease the provision is derecognised, as the premises is made good.

CBMS journal entries: Premises is made good at 30 June 20X5

Dr/Cr	CBMS account	CBMS account description	Amount ($)
Dr	3381008	Provisions for restoration, decommissioning and make good	50,000
Cr	5220000	Cash	50,000

Disclosure

The movement schedule disclosures that are required for each year are as follows:

Note X: Other Provisions [extracts for 20X0 – 20X5]

	20X0-1 $’000	20X1-2 $’000	20X2-3 $’000	20X3-4 $’000	20X4-5 $’000
As at 1 July	-	34	38	41	45
Additional provisions made	31	-	-	-	-
Amounts used	-	-	-	-	(50)
Unwinding of discount or change in discount rate	3	3	4	4	5
Total* as at 30 June	34	38	41	45	-

^{* rounding differences}

Scenario: Using the same scenario as IE1, assume that at 1 July 20X2 the entity increases its estimated eventual make good costs estimate by $20,000. It is assumed that no credit balance exists in ARR.[1] 

Accounting treatment

Up until 30 June 20X2, the accounting treatment at IE1 applies.

At 1 July 20X2, the entity must increase the provision to reflect the increase of $20,000 in expected cost to make good the premises. As the balance of the provision at 30 June 20X2 is $37,566 (calculated at IE1 as $31,046 +$3,105 +$3,415), the entity must recognise the difference, being:

Increase in provision     = $52,592 ($70,000 / (1.10)³) – $37,566       = $15,026

CBMS journal entries: Recognition of the increase in the provision in the operating statement

Dr/Cr	CBMS account	CBMS account description	Amount ($)
Dr	2254001	Buildings – Write Down and Impairment*	15,026
Cr	3381008	Provisions for restoration, decommissioning and make good	15,026

^{* Posting would be to ARR to the extent credit balance exists for that asset class}

The entity would be required to recognise the unwinding of the discount as a finance cost as it occurs (as in IE1).

The periodic unwinding of the discount will now be recognised in respect of the increased amount of $52,592 as follows:

CBMS journal entries: Unwinding of the discount

Dr/Cr	CBMS Account	CBMS account description	30/06/X3 $	30/06/X4 $	30/06/X5 $
Dr	2422008	Unwinding of discount on restoration (expense)	5,259	5,785	6,364
Cr	3381008	Provisions for restoration, decommissioning and make good	5,259	5,785	6,364

Total make good provision before and after increase on 1 July 20X2 in expected settlement costs

Year	Total provision before increase ($)	Total provision after increase ($)
30/06/20X1	34,151	34,151
30/06/20X2	37,566	37,566
01/07/20X2	37,566	52,592*
30/06/20X3	41,322	57,851
30/06/20X4	45,455	63,636
30/06/20X5	50,000	70,000

^{* Calculated by adding the prior year’s total provision with the increase in provision due to the increase in the expected cost to make good the premises (i.e. 37,566 + 15,026 = 52,596)}

The entity would also be required to depreciate the leasehold improvements asset over the term of the lease (as in IE1).

As the premises is made good at the end of the lease a journal entry for $70,000 is required (similar to that in IE1).

Disclosure

The movement schedule disclosures required for the remaining three years are now as follows:

Note X: Other Provisions [extracts for 20X3 – 20X5]

	20X3 $’000	20X4 $’000	20X5 $’000
As at 1 July	38	58	64
Additional provisions made	15	-	-
Amounts used	-	-	(70)
Unwinding of discount or change in discount rate	5	6	6
Total as at 30 June	58	64	-

Scenario: An entity enters into a 5 year lease for an office block on 1 July 20X0. The lease liability recognised on lease commencement is $1,000,000.

There are no initial lease direct costs, lease accruals or incentives on commencement and the lessee does not make any leasehold improvements. The contract specifies that the entity must make good the leased premises at the end of the lease term, including cleaning the carpets and repainting offices.

For this scenario:

• the cost of the ROU asset will include an estimate of the cost of making good the premises at the end of the lease
• the entity estimates that at 1 July 20X0 it would cost approximately $40,000 to return the building to its original condition
• assume the entity depreciates ROU assets on a straight-line basis, a discount rate of 10% applies and inflation is estimated to be 4.5% per annum.

Accounting treatment

Initial accounting

At 1 July 20X0, the following journal is posted to recognise the initial lease and make good provision balances:

CBMS journal entries: Recognition of the initial lease and make good provision balances

Dr/Cr	CBMS account	Mmt Code	CBMS account description	Amount ($)
Dr	5311002	7321	Buildings - ROU Asset	1,031,046
Cr	3240102		Lease Liabilities – Adjustments	1,000,000
Cr	3381008		Provisions for restoration, decommissioning and make good	31,046

Subsequent accounting

Over the life of the lease term, the discount is unwound to the full $50,000. The following formula is repeated in this process through to the end of the lease term:

Increase in provision   = (PV for current year) – (PV for prior year)
 

For example, to calculate the increase in provision as at 30 June 20X1:

Increase in provision
at 30/06/20X1                = ($50,000 / (1.10)⁴) – $31,046         = $3,105

CBMS journal entries: Unwinding of the discount

Dr/Cr	CBMS Account	CBMS account description	30/06/X1 $	30/06/X2 $	30/06/X3 $	30/06/X4 $	30/06/X5 $
Dr	2422008	Unwinding of discount on restoration (expense)	3,105	3,415	3,756	4,133	4,545
Cr	3381008	Provisions for restoration, decommissioning and make good	3,105	3,415	3,756	4,133	4,545

The entity will also recognise depreciation expense of $206,209 for years 1-5 in relation to the ROU asset. This is derived from the cost of the ROU asset of $1,031,046 depreciated on a straight-line basis over the term of the lease (5 years).

CBMS journal entries: Depreciation of ROU asset (this journal is repeated (1 July 20X0 – 20X5))

Dr/Cr	CBMS account	Mmt Code	CBMS account description	Amount ($)
Dr	2241002		Buildings - Depreciation	206,209
Cr	5311002	7353	Buildings - Accumulated depreciation ROU Asset	206,209

 

At the end of the lease term the provision is derecognised as the premises is made good.

CBMS journal entries: Derecognising the provision as premises is made good at 30 June 20X5

Dr/Cr	CBMS account	CBMS account description	Amount ($)
Dr	3381008	Provisions for restoration, decommissioning and make good	50,000
Cr	5220000	Cash	50,000

Disclosure

The movement schedule disclosures that are required for each year are as follows:

Note X: Other Provisions [extracts for 20X1 – 20X5]

	20X1 $’000	20X2 $’000	20X3 $’000	20X4 $’000	20X5 $’000
As at 1 July	-	34	37	41	45
Additional provisions made	31	-	-	-
Amounts used	-	-	-	-	(50)
Unwinding of discount or change in discount rate	3	3	4	4	5
Total as at 30 June	34	37	41	45	-

 

Scenario: Assume the same information as IE3, however assume that at 1 July 20X2 the entity makes changes to the building, creating a number of new offices and meeting rooms and the changes made lead to an increase of $20,000 in the expected cost to make good the premises.

Note: Because the relevant asset is held at cost, accounting for the increase in the make good provision would be the same if the increase in estimated eventual restoration costs was not due to any specific actions taken by the lessee, such as further fitout works. As noted in the introduction, this may not be the case where the relevant asset is held at fair value.

Accounting treatment

Up until 30 June 20X2 (inclusive), the accounting treatment at IE3 applies.

At 1 July 20X2, the entity must increase the provision to reflect the increase of $20,000 in expected cost to make good the premises. As the balance of the provision at 30 June 20X2 is $37,566 (calculated at IE1 as $31,046 +$3,105 +$3,415), the entity must recognise the difference:

Increase in provision = ($70,000 / (1.10)³) – 37,566 = 52,592 – 37,566 = $15,026

CBMS journal entries: Recognise the increase in the make good provision

Dr/Cr	CBMS account	Mmt Code	CBMS account description	Amount ($)
Dr	5311002	7321	Buildings (ROU Asset)	15,026
Cr	3381008		Provisions for restoration, decommissioning and make good	15,026

The entity would be required (as in IE3) to recognise the unwinding of the discount as a finance cost as it occurs. The periodic unwinding of the discount will now be recognised for the increased provision amount of $52,592, as follows:

CBMS journal entries: Unwinding of the discount

Dr/Cr	CBMS Account	CBMS account description	30/06/X3 $	30/06/X4 $	30/06/X5 $
Dr	2422008	Unwinding of discount on restoration (expense)	5,259	5,785	6,364
Cr	3381008	Provisions for restoration, decommissioning and make good	5,259	5,785	6,364

Make good provision before and after increase on 1 July 20X2 in the expected settlement costs

Year	Total provision before increase ($)	Total provision after increase ($)
30/06/X1	34,151	34,151
30/06/X2	37,566	37,566
01/07/X2	37,566	52,592*
30/06/X3	41,322	57,851
30/06/X4	45,455	63,636
30/06/X5	50,000	70,000

^{*Calculated by adding the prior year’s provision with the increase in provision due to the increase in the expected cost to make good the premises (i.e. 37,566 + 15,026 = 52,596)}

The entity would also be required to depreciate the ROU asset over the term of the lease (as in IE3 but adjusted from the 20X2-X3 reporting period).

As the premises is made good at the end of the lease, a journal entry similar to that in IE3 but for $70,000 is required.

Disclosure

The movement schedule disclosures required for the remaining three years are now as follows:

Note X: Other Provisions [extracts for 20X3 – 20X5]

	20X3 $’000	20X4 $’000	20X5 $’000
As at 1 July	38	58	64
Additional provisions made	15	-	-
Amounts used	-	-	(70)
Unwinding of discount or change in discount rate	5	6	6
Total as at 30 June	58	64	-