IFRIC 1 (International Financial Reporting Interpretations Committee 1) provides guidance on how to account for changes in existing decommissioning, restoration, and similar liabilities. This interpretation applies to entities in all industries that have obligations to restore or decommission assets at the end of their useful lives, or when they are no longer in use. In this article, we will explain the key definitions and provide examples and case studies to illustrate the application of IFRIC 1.
Decommissioning: the process of removing or dismantling an asset and restoring the site to its original condition, or to a specified alternative use.
Restoration: the process of returning a site to its original condition or to a specified alternative use.
Similar liabilities: obligations to perform activities that are similar to decommissioning or restoration, such as environmental cleanup, site remediation, or asset retirement obligations.
IFRIC 1 deals with situations where an entity has a liability for decommissioning, restoration, or similar activities, and there is a change in the expected timing or amount of that liability. For example, the entity may have to decommission an asset earlier than expected, or the cost of decommissioning may be higher than initially estimated.
Under IFRIC 1, the entity must recognize the changes in the liability as an adjustment to the carrying amount of the asset, and as an expense in the income statement. The adjustments must be made in the period in which the change in the liability occurs, regardless of whether the liability is expected to be settled in the current or future periods.
Company X operates a power plant and has a decommissioning liability of $10 million. The liability relates to the decommissioning of the plant at the end of its useful life, which is expected to be in 10 years. At the end of year 1, the company revises its estimate of the decommissioning cost and now expects it to be $12 million instead of $10 million. Company X must recognize the increase in the liability as an adjustment to the carrying amount of the plant and as an expense in the income statement in year 1.
In 2016, the UK government announced that it would phase out coal-fired power plants by 2025. This decision had a significant impact on energy companies with coal-fired power plants, as they now had to decommission their plants earlier than expected. One such company was RWE, which had a decommissioning liability of €1.8 billion for its coal-fired power plants in the UK.
Following the government’s announcement, RWE revised its estimate of the decommissioning cost and increased it by €500 million. The company recognized the increase in the liability as an adjustment to the carrying amount of the plants and as an expense in the income statement in the year of the announcement.
IFRIC 1 provides guidance on how to account for changes in existing decommissioning, restoration, and similar liabilities. The key principle is that changes in the liability must be recognized as an adjustment to the carrying amount of the asset and as an expense in the income statement. This ensures that the financial statements reflect the current estimate of the liability and the associated costs. The examples and case studies in this article illustrate the application of IFRIC 1 in practice.