ACCOUNTING FOR RESTORATION COST…

As an auditor or a company accountant, one needs to take note of the agreement of any leased property/building. If the terms of the lease require the company to restore the building to its former state, then, restoration cost needs to be factored into the cost of the property/building. The same still applies even if the building is not leased. If constructed or bought and it is required, legally or constructively, to restore the site to its former state, then restoration/decommissioning cost should be accounted for.

Recognition and Measurement

Only when there is a legal or constructive obligation to restore a building/property/site is restoration cost recognized. The amount to be recognized would be a best estimate of what could be incurred. Since this involve an estimate, considerable judgement is required here. However, the estimate should be reasonable.

The future value of the restoration cost should be estimated. One way of doing this is to estimate what it would cost if the restoration is done now and to then grow this amount using an inflation rate. Where the effects of time value of money is material (which is the case most times), the future value of the restoration cost would be discounted. The discount rate to be used can be the weighted average cost of capital (WACC) of the company. Where this is difficult to compute, a risk free rate of interest plus a risk premium specific to the company can be used. 

The discounted value will be recognized as part of the cost of the asset and as a liability.

a. On initial recognition:

Dr Leased property/building

Cr Provision

b. Subsequent recognition

If discounted, the discount should be unwound at the end of each year. For illustration, the initial recognition is at 31 December 20X1, and the discounted value is N3,000,000.

Dr Leased property/building  (N3,000,000)

Cr Provision (N3,000,000)

As at 31 December 20X2, take the discount rate as 1%, the double entry in 20X2 would be:

Dr Finance cost (N30,000 – the discount rate 1% x N3,000,000)

Cr Provision (N30,000)

This is called unwinding of the discount, and it would be treated as a finance charge. The idea behind this is to grow the discounted value to the future value by the time the restoration is to be done.

The cost of the leased property/building should be depreciated over the useful life of the asset. The rationale behind this is that the future restoration cost is tied to the asset and recognized over its useful life than at the time the restoration work is to be done. 

Appropriate disclosure is to be made in the financial statements of the description of the future restoration cost, the related asset, and a reconciliation of the beginning and ending balance of the provision.

We appreciate your comments.

Written by Abayomi Samuel