226. A quarry operator is legally required to backfill the ground it excavates, at an estimated CU 15 for each tonne extracted, and the obligation arises as each tonne is extracted. In the year it extracted 200,000 tonnes at a direct extraction cost of CU 40 a tonne and sold 150,000 tonnes. How is the CU 15 a tonne restoration cost accounted for at the year end?

A) A provision of CU 3,000,000 is recognised and the whole amount is charged to cost of sales, since restoration relates to damage, not to stock
B) A provision of CU 3,000,000 is recognised, of which CU 750,000 is included in closing inventory cost and CU 2,250,000 in cost of sales
C) A provision of CU 3,000,000 is recognised and the whole amount is added to the cost of the quarry plant, as a decommissioning cost
D) A provision of CU 2,250,000 is recognised for the tonnes sold only, with unsold stock at extraction cost and the rest recognised on sale

Correct: B complex IAS 16.18, IAS 2

The obligation arises as each tonne is extracted, so the provision at the year end covers all 200,000 tonnes: 200,000 x 15 = CU 3,000,000. IAS 16 says that costs of restoring a site that are incurred as a consequence of using an item to produce inventory in a period are accounted for under IAS 2, so the restoration cost is part of the cost of the tonnes produced. The 50,000 tonnes unsold carry 50,000 x 15 = CU 750,000 in inventory, and the 150,000 tonnes sold carry CU 2,250,000 in cost of sales. Capitalising to the plant would apply the decommissioning rules to an obligation arising from production, and provisioning only for tonnes sold ignores that the obligation arises on extraction.

227. A company's draft figures show profit before interest and tax (PBIT) of CU 1,200,000, equity of CU 5,000,000 and non-current borrowings of CU 3,000,000, so return on capital employed, measured as PBIT / (equity + non-current liabilities), is 15%. The auditors require a provision of CU 400,000 for a lawsuit expected to be settled in two years, with no tax effect and ignoring discounting. What is the return on capital employed after the provision is recognised?

A) 15.8%, because the provision is a one-off item excluded from PBIT, while capital employed falls to CU 7,600,000 as equity is reduced
B) 9.5%, because PBIT falls to CU 800,000 and capital employed rises to CU 8,400,000, as the provision is added to non-current liabilities
C) 10.0%, because PBIT falls to CU 800,000 while capital employed stays at CU 8,000,000, as lower equity is offset by the provision
D) 10.5%, because PBIT falls to CU 800,000 and capital employed falls to CU 7,600,000, as equity is reduced by the new provision

Correct: C difficult IAS 37.14

The provision is charged to profit, so PBIT falls from CU 1,200,000 to CU 800,000, and equity falls by CU 400,000. The provision is a non-current liability, so non-current liabilities rise by the same CU 400,000, and capital employed of equity plus non-current liabilities stays at CU 8,000,000. Return on capital employed is therefore 800,000 / 8,000,000 = 10.0%. Using a reduced base of CU 7,600,000 forgets the offsetting liability, adding the provision to an unchanged equity double counts it, and excluding the charge from PBIT contradicts the recognition of the expense.