Q1 and Q2: Exam Notes on Provisions and Discount Rates

Discount Rates and Present Value

Assume a 10% discount rate for current calculations.
In future courses (Manac, Finac, PGT A), you will learn to determine the inputs of discount rates.
For current purposes, a discount rate adjusts a future amount to its present value.

Rehabilitation Provision Example

Scenario: Agreement on Jan 1 to rehabilitate terrain in 3 years.
Expected cost in 3 years: 7,986,000.
Financial statements need amounts in today's money.
Given: Present value is 600,000 on Jan 1.

HP Calculator Usage (Red Buttons)

Focus on red buttons (financial calculator functions).
Interested in the first row of red button: N, I/YR, PV, PMT, FV.
Also, red second function and C (clear all) button.
Clear all: Second function + C.
To show more decimals: Second function + = sign (adds zeros).

Calculating Present Value

Input 798600 as future value (FV).
Input 10 as interest per year (I/YR).
Input 3 as N (number of years).
Input 0 as PMT (payment).
Compute present value (PV) to get 600,000.

Adjusting Payment Period

Enter 1, then press red second function, then press N.
Change the payment period to 1.
Recalculate present value.
- Future Value (FV) 798600
- Interest per year 10
- N = 3
- PMT = 0

Interest Calculation for Each Year

Write down key points (FV, I/YR, PMT, N) to get marks even if PV is incorrect.

Year 1 Interest

Press 1, then Input button (1 Input 1).
Press second function, then AMORT (amortization).
Press = twice to see the interest amount: 60,000 (Year 1 finance cost).

Year 2 Interest

Press 2, then Input button (2 Input 2).
Press second function, then AMORT.
Press = twice to get the interest: 6,000.

Year 3 Interest

Press 3, then Input button (3 Input 3).
Press second function, then AMORT.
Press = twice to get the interest for year three.
Press = again to see the final amount: $7,986,000$.

Accounting Perspective

Adjusting for the time value of money ensures the provision isn't stuck at 600,000 for three years. 600,000 is only applicable on day one.

Journal Entries

Day 1: Debit Rehabilitation cost 600,000, Credit Provision 600,000.
End of Year 1: Debit Finance cost (time value of money), Credit Provision.
End of Year 3: Provision should be 7,986,000.
Journal for consuming the provision: Debit Provision 7,986,000, Credit Cash 7,986,000 (can be other assets, not always cash).

PPE Notes Over Three Years

Year 1:
- Start: Nothing.
- Raise provision (present value): 600,000.
- Finance cost adjustment: 60,000 (contra account: Finance cost, not interest).
Year 2:
- Opening balance: Previous closing balance.
- Finance cost adjustment for year two.
Year 3:
- Opening balance.
- Finance cost adjustment.
- Use the full amount; ending balance is zero.

Over/Under Provision Scenarios

Scenario: Paying More Than Provided

If actual payment exceeds the provision, adjust the provision or adjust everything together.
Example: Paying 800,000, provision was 7,986,000.
Journal: Adjust everything together expensing any unexpected amount.
- Rehabilitation cost of the additional amount.
- Expense the extra amount that was unexpected.

Insurance and Provisions (Question 2 Summary)

Provision for Legal Claims

Raise a provision if there's a probability of a successful claim.
If insured, insurance recovery must be virtually certain to write a journal.
Scenario: Pay 100,000, insurance cover of 80,000.

Journal Entries

Debit Claim Expense, Credit Provision (Legal Claim Provision).
Calculate amount: single liability method or probability-weighted average.

Insurance Recovery

Debit Insurance Debtor, Credit Insurance Income.
IAS 37: Reimbursements reduce the expense, they don't go to insurance income.
SCI: Claim Expense is 100,000 - 80,000 = 20,000.
SFP: Show liability and asset balances separately.

Over-Insured Scenario

If reimbursement exceeds the liability, can't recognize more than the original liability.
Example: Receive 150,000, but the original liability is 100,000. Recognize only 100,000. Reduce claim to match liability.