Discounting and discount rate

Learning objectives

• Calculate the present value of a future cash outflow when the effect of discounting is material.L2, L3
• Determine the discount rate: pre-tax, reflecting the time value of money and the risks specific to the liability that have not already been reflected in the cash flows.L2, L3, L4
• Recognise a discounted provision, including a decommissioning provision included in the cost of an item of property, plant and equipment under IAS 16.L2, L3

Normative references

• IAS 37 §45Where the effect of the time value of money is material, the amount of a provision is the present value of the expenditures expected to be required to settle the obligation.
• IAS 37Because of the time value of money, cash outflows that arise soon after the reporting period are more onerous than outflows of the same amount that arise later; provisions are therefore discounted where the effect is material.
• IAS 37 §47The discount rate (or rates) is a pre-tax rate (or rates) that reflects current market assessments of the time value of money and the risks specific to the liability; it does not reflect risks for which future cash flow estimates have already been adjusted.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

12 questions

• A provision is always measured at its nominal amount, whatever the timing of the cash outflow.L2
• What characteristics must the discount rate of a provision have?L2
• Arnavel has undertaken to clean up land whose soil it contaminated. The expenditure, estimated at {expected_outflow}, will be incurred in {years_to_settlement} years; the effect of discounting is material and the pre-tax rate used (case data) is {pre_tax_rate}%. Compute the provision at the reporting date (rounded to the nearest unit).L2
• A combined heat and power plant of Belmondane must be decommissioned in {horizon} years, at a cost estimated at {nominal_cost} at that date's prices, already adjusted for the risks specific to decommissioning. The pre-tax rate reflecting the time value of money is {discount_rate}%; the corresponding post-tax rate is {post_tax_rate}%. What provision does Belmondane recognise today (rounded to the nearest unit)?L3
• On 31 December 20X5, Cendral completes the construction of a telecommunications tower on public land; the permit requires it to dismantle the tower in {years} years, at an estimated cost of {decommissioning_cost}. The pre-tax rate used is {rate}%. The IAS 16 criteria for including the initial estimate of the dismantling cost in the cost of the tower are met (case data). Record the entry setting up the provision (amount rounded to the nearest unit).L2
• At the end of 20X5, Dorvalis brings into service a water treatment plant built on concession land. The concession requires the installations to be removed and the land returned in {years} years; the cost, estimated at {removal_cost}, is discounted at the pre-tax rate of {rate}%. The IAS 16 criteria for including this initial estimate in the cost of the plant are met (case data). Record the provision when it is set up (amount rounded to the nearest unit).L3
• Elmara estimated the cash flows for restoring a site by increasing them with a margin for the risk of cost overruns. It then discounts these cash flows at a pre-tax rate increased by a premium for the same overrun risk. Where is the error?L3
• Fervelline must decommission a test platform in 20 years, at an estimated cost of 3,000,000; the effect of discounting is material. Its accountant recognises a provision of 3,000,000. What is the error?L2
• Galdrian must choose the discount rate for a restoration provision whose cash flows are already adjusted for all the risks specific to the obligation. It has four rates: 3.1% (post-tax risk-free rate), 6% (pre-tax rate including a premium for the obligation's risks), 4.2% (pre-tax rate reflecting only the current time value of money) and 2.5% (rate used when the provision was set up six years ago). Which rate should be used?L3
• An entity may discount a provision at a post-tax rate as long as it applies that rate consistently.L3
• Hirvane has two provisions at its reporting date: (1) a settlement payment of 120,000 due in three months; (2) an obligation to restore a mining site, of 4,000,000, to be carried out in twelve years. How should discounting be dealt with?L4
• Isomarel estimates the cash flows for decommissioning a terminal in amounts not adjusted for risk. The risks specific to the obligation (technical uncertainty, delays) are therefore not reflected in the cash flows. How should the discount rate take them into account?L4