Capitalise the PV, accrete the liability, depreciate the asset

An obligation that comes with the asset

Cobalt Ridge Mining Corp. opens a mine in northern Ontario. Its operating licence requires it to restore the site when mining ends in ten years; engineers estimate the restoration will cost $1,000,000 at that time. The obligation is real, present, and probable from the day the first shovel goes in — but it is ten years away, and money ten years away is worth less than money today.

Three rules govern the accounting:

1. The provision is measured at the present value of the expected expenditure. At Cobalt Ridge’s 6 % rate, the ten-year PV factor is 0.5584 (from the table the prompt supplies): $1,000,000\times 0.5584=558,400$.
2. Because the obligation is a cost of acquiring the right to mine — the site could not be used without the promise to restore it — the same amount is capitalised into the asset, not expensed.
3. Each year, two things happen: the discount unwinds (the liability grows toward $1,000,000 at 6 %), and the capitalised cost is depreciated over the mine’s life.

Worked example

Initial recognition — the PV goes into the asset and the provision at once; no cash moves:

Dr Mine Site Asset                     558,400
    Cr Decommissioning Provision                 558,400

Year 1 — accretion. The provision grows by one year’s interest at the discount rate: $558,400\times 6\%=33,504$. The expense is called accretion expense (or unwinding of the discount); it is a financing-type charge, not interest on a loan, and the credit goes to the provision itself, not to Interest Payable:

Dr Accretion Expense                    33,504
    Cr Decommissioning Provision                  33,504

The provision now stands at $558,400+33,504=591,904$.

Year 1 — depreciation. The capitalised $558,400 is depreciated straight-line over the ten-year life: $558{,}400 \div 10 = 55{,}840$ per year:

Dr Depreciation Expense                 55,840
    Cr Accumulated Depreciation—Mine Site         55,840

Year 2 — accretion is computed on the grown balance: $591,904\times 6\%=35,514$ (rounded to the dollar). Accretion rises every year, like interest on a growing balance; depreciation is the same $55,840 every year.

Why total expense equals the undiscounted obligation

Over ten years the depreciation entries total $558,400 (the PV) and the accretion entries total $441,600 (the growth from PV to $1,000,000).Together:\ast \ast$1,000,000** — exactly the cash Cobalt Ridge will pay to restore the site. Discounting changes when the expense is recognised, not how much. When the site is restored, the entry is Dr Decommissioning Provision 1,000,000 / Cr Cash 1,000,000, and the provision is gone.

Legal and constructive obligations

Cobalt Ridge’s licence makes this a legal obligation. IFRS also recognises a constructive obligation — one created by a company’s own published policy or public commitment, where it has raised a valid expectation that it will act even without a legal duty. A mining company that publicly commits to restore every site it operates, including ones its licences do not cover, has a constructive obligation for those sites too, and under IFRS it recognises a provision for them. ASPE recognises only the legal obligation (lesson 6.7).