Revaluation model: Nuclear power plant and decommissioning liability

These examples accompany, but are not part of, IFRIC 1.

Common facts

An entity has a nuclear power plant and a related decommissioning liability. The nuclear power plant started operating on 1 January 2000. The plant has a useful life of 40 years. Its initial cost was CU120,0001; this included an amount for decommissioning costs of CU10,000, which represented CU70,400 in estimated cash flows payable in 40 years discounted at a risk-adjusted rate of 5 per cent. The entity’s financial year ends on 31 December.

Example: Revaluation model

The entity adopts the revaluation model in IAS 16 whereby the plant is revalued with sufficient regularity that the carrying amount does not differ materially from fair value. The entity’s policy is to eliminate accumulated depreciation at the revaluation date against the gross carrying amount of the asset.

When accounting for revalued assets to which decommissioning liabilities attach, it is important to understand the basis of the valuation obtained. For example:

  1. if an asset is valued on a discounted cash flow basis, some valuers may value the asset without deducting any allowance for decommissioning costs (a “gross” valuation), whereas others may value the asset after deducting an allowance for decommissioning costs (a “net” valuation), because an entity acquiring the asset will generally also assume the decommissioning obligation. For financial reporting purposes, the decommissioning obligation is recognised as a separate liability, and is not deducted from the asset. Accordingly, if the asset is valued on a net basis, it is necessary to adjust the valuation obtained by adding back the allowance for the liability, so that the liability is not counted twice. [[3]]
  2. if an asset is valued on a depreciated replacement cost basis, the valuation obtained may not include an amount for the decommissioning component of the asset. If it does not, an appropriate amount will need to be added to the valuation to reflect the depreciated replacement cost of that component.

Assume that a market-based discounted cash flow valuation of CU115,000 is obtained at 31 December 2002. It includes an allowance of CU11,600 for decommissioning costs, which represents no change to the original estimate, after the unwinding of three years’ discount. The amounts included in the balance sheet at 31 December 2002 are therefore:

CU
Asset at valuation (1)126,600
Accumulated depreciation nil
Decommissioning liability (11,600)
Net assets115,000
Retained earnings (2)(10,600)
Revaluation surplus (3) 15,600

Notes:

  1. Valuation obtained of CU115,000 plus decommissioning costs of CU11,600, allowed for in the valuation but recognised as a separate liability = CU126,600.
  2. Three years’ depreciation on original cost CU120,000 × 3/40 = CU9,000 plus cumulative discount on CU10,000 at 5 per cent compound = CU1,600; total CU10,600.
  3. Revalued amount CU126,600 less previous net book value of CU111,000 (cost CU120,000 less accumulated depreciation CU9,000).

The depreciation expense for 2003 is therefore CU3,420 (CU126,600 x 1/37) and the discount expense for 2003 is CU600 (5 per cent of CU11,600). On 31 December 2003, the decommissioning liability (before any adjustment) is CU12,200 and the discount rate has not changed. However, on that date, the entity estimates that, as a result of technological advances, the present value of the decommissioning liability has decreased by CU5,000. Accordingly, the entity adjusts the decommissioning liability from CU12,200 to CU7,200.

The whole of this adjustment is taken to revaluation surplus, because it does not exceed the carrying amount that would have been recognised had the asset been carried under the cost model. If it had done, the excess would have been taken to profit or loss in accordance with paragraph 6(b). The entity makes the following journal entry to reflect the change:

CUCU
Dr decommissioning liability5,000 
Cr revaluation surplus  5,000

The entity decides that a full valuation of the asset is needed at 31 December 2003, in order to ensure that the carrying amount does not differ materially from fair value. Suppose that the asset is now valued at CU107,000, which is net of an allowance of CU7,200 for the reduced decommissioning obligation that should be recognised as a separate liability. The valuation of the asset for financial reporting purposes, before deducting this allowance, is therefore CU114,200. The following additional journal entry is needed:

CUCU
Dr accumulated depreciation (1) 3,420 
Cr asset at valuation  3,420
Dr revaluation surplus (2)8,980 
Cr asset at valuation (3)  8,980

Notes:

  1. Eliminating accumulated depreciation of CU3,420 in accordance with the entity’s accounting policy.
  2. The debit is to revaluation surplus because the deficit arising on the revaluation does not exceed the credit balance existing in the revaluation surplus in respect of the asset.
  3. Previous valuation (before allowance for decommissioning costs) CU126,600, less cumulative depreciation CU3,420, less new valuation (before allowance for decommissioning costs) CU114,200.

Following this valuation, the amounts included in the balance sheet are:

CU
Asset at valuation114,200
Accumulated depreciation nil
Decommissioning liability (7,200)
Net assets107,000
Retained earnings (1)(14,620)
Revaluation surplus (2) 11,620

Notes:

  1. CU10,600 at 31 March 20X2 plus 20X3’s depreciation expense of CU3,420 and discount expense of CU600 = CU14,620.
  2. CU15,600 at 31 March 20X2, plus CU5,000 arising on the decrease in the liability, less CU8,980 deficit on revaluation = CU11,620.