- 20 Marks
Question
AFEN Ltd. obtained a license, free of charge from the government, to dig and operate a gold mine. AFEN Ltd. spent GH$6 million digging and preparing the mine for operation and erecting buildings on the site. The mine commenced operations on 1 September 2022. The license requires that at the end of the mine’s useful life of 20 years, the site must be reclaimed, all buildings and equipment must be removed and the site landscaped. At 31 August 2023, AFEN Ltd. estimated that the cost in 19 years’ time of the removal and landscaping will be GH$5 million and its present value is GH$3 million.
On 31 October 2023, there was a massive earthquake in the area and AFEN Ltd’s mine shaft was badly damaged.It is estimated that the mine will be closed for at least six (6) months and will cost GH$1 million to repair.
You are required to:
Explain the accounting treatment for the license, the development costs, the reclamation provision, and the earthquake damage in the financial statements for the year ended 31 August 2023.
Answer
The accounting treatment is as follows:
- License: The license is obtained free of charge, so no cost is recorded for the license itself. It does not meet the cost measurement criterion for recognition as an intangible asset under IAS 38.
- Development costs: The GH¢6 million spent on digging, preparing the mine, and erecting buildings is capitalized as property, plant and equipment (PPE) under IAS 16, as these costs are directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended.
- Reclamation provision: The obligation to reclaim the site is a legal obligation arising from the license. Under IAS 37, a provision is recognized for the present value of the estimated costs GH¢3 million. This provision is added to the cost of the PPE, making the total capitalized cost GH¢6 million + GH¢3 million = GH¢9 million.
- The PPE is depreciated over the 20-year useful life, so depreciation expense for the year ended 31 August 2023 is GH¢9 million / 20 = GH¢0.45 million (full year assumed).
- The provision is unwound each year, increasing the provision and recognizing finance cost in profit or loss. The discount rate is implied by the PV calculation (approximately 2.72% since (5/3)^(1/19) ≈ 1.0272).
- Earthquake damage: The earthquake occurred on 31 October 2023, after the reporting date of 31 August 2023. Under IAS 10, this is a non-adjusting subsequent event. No adjustment is made to the financial statements for the year ended 31 August 2023, but if material, disclose the nature of the event, estimate of financial effect (damage and repair cost GH¢1 million, closure for 6 months), in the notes.
- In the subsequent year, the damage triggers an impairment review under IAS 36. The carrying amount of the mine asset is tested against recoverable amount (higher of value in use and fair value less costs of disposal). If impaired, write down the asset.
- The repair cost GH¢1 million is capitalized to the PPE cost when incurred, as it restores the asset’s service potential, and depreciated over the remaining useful life.
- Tags: IAS 10, IAS 16, IAS 36, IAS 37, Impairment, PPE Capitalisation, Provision for Reclamation, Subsequent Events
- Level: Level 3
- Topic: Fair Value Accounting
- Series: APR 2024
- Uploader: Samuel Duah