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

1. Input $798600$ as future value (FV).

2. Input 10 as interest per year (I/YR).

3. Input 3 as N (number of years).

4. Input 0 as PMT (payment).

5. Compute present value (PV) to get $600,000$.

Adjusting Payment Period

1. Enter 1, then press red second function, then press N.

2. Change the payment period to 1.

3. 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

1. Press 1, then Input button (1 Input 1).

2. Press second function, then AMORT (amortization).

3. Press = twice to see the interest amount: $60,000$ (Year 1 finance cost).

Year 2 Interest

1. Press 2, then Input button (2 Input 2).

2. Press second function, then AMORT.

3. Press = twice to get the interest: $6,000$.

Year 3 Interest

1. Press 3, then Input button (3 Input 3).

2. Press second function, then AMORT.

3. Press = twice to get the interest for year three.

4. 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.