Key Takeaways
- The provision is recognised at the same time as the related asset, not when dismantling actually begins.
- Initial measurement uses a pre-tax discount rate reflecting current market assessments; European industrials commonly apply rates between 2% and 5% for long-dated obligations.
- Changes in the estimated cost or the discount rate adjust the asset's carrying amount (not profit or loss) under the cost model, following IFRIC 1.
- Failing to recognise or remeasure a decommissioning provision understates both the liability and the related asset on the balance sheet.
What is Decommissioning Obligation?
When an entity installs an asset that creates a legal or constructive obligation to dismantle, remove, or restore the site, IAS 16.16(c) requires the estimated dismantling cost to be included in the asset's cost at initial recognition. The corresponding credit goes to a provision measured under IAS 37.36 as the best estimate of the expenditure required to settle the obligation, discounted to present value when the time value of money is material (IAS 37.45).
IFRIC 1.3–5 governs what happens after day one. If the entity uses the cost model, changes in the estimated cash flows or the discount rate adjust the asset's carrying amount (and hence future depreciation), not profit or loss directly. The unwinding of the discount is recognised as a finance cost each period. This two-part movement (the asset side and the liability side moving on different schedules) is where documentation tends to break down. The auditor evaluates the estimation method and inputs under ISA 540.13(a), paying particular attention to whether the cash flow projections reflect current prices and whether the discount rate has been updated for changes in market rates since the prior year.
Worked example: Henriksen Shipping A/S
Client: Danish maritime logistics company, FY2025, revenue EUR 140M, IFRS reporter. Henriksen operates a fuel storage terminal on leased land near Esbjerg. The lease runs until 2040. At commissioning in January 2020, an independent environmental engineer estimated the cost to dismantle the terminal and remediate the site at EUR 4.8M in 2040 prices.
Step 1 — Recognise the initial provision
The obligation is legal (the lease contract requires full site restoration). At commissioning in January 2020, Henriksen discounts the EUR 4.8M at a pre-tax rate of 3.2% over 20 years. Present value: EUR 4,800,000 / (1.032)^20 = EUR 2,556,000 (rounded). The provision of EUR 2,556,000 is credited to liabilities, and the same amount is added to the cost of the terminal asset under IAS 16.16(c).
Documentation note: record the obligating event (lease restoration clause), the cost estimate source (environmental engineer report dated January 2020), the discount rate derivation, and the present value calculation per IAS 37.45–47.
Step 2 — Unwind the discount through FY2025
Each year the provision increases by the discount rate applied to the opening balance. By 31 December 2025 (six full years of unwinding at 3.2%), the provision has grown to EUR 2,556,000 x (1.032)^6 = EUR 3,089,000 (rounded). The cumulative unwinding of EUR 533,000 has been recognised as finance cost over the six years.
Documentation note: record the annual unwinding charge for each year, cross-reference to the finance cost line in the income statement, and reconcile the opening and closing provision balance per IAS 37.84(e).
Step 3 — Reassess the estimate at year-end 2025
An updated environmental report in November 2025 revises the expected remediation cost to EUR 5.4M in 2040 prices (an increase of EUR 600,000 in nominal terms). Market discount rates have also shifted; Henriksen updates the rate to 3.5%. The revised provision is EUR 5,400,000 / (1.035)^15 = EUR 3,230,000 (rounded, 15 years remaining). The adjustment from the current carrying amount of EUR 3,089,000 to EUR 3,230,000 (EUR 141,000) is added to the terminal asset's carrying amount under IFRIC 1.5(a), not charged to profit or loss.
Documentation note: record the revised cost estimate (attach the updated environmental report), the revised discount rate and its source, the recalculated provision, and the adjustment to the asset's carrying amount. Cross-reference IFRIC 1.5(a) for cost-model treatment.
Step 4 — Adjust depreciation prospectively
The terminal's remaining useful life is 15 years (to 2040). The EUR 141,000 added to the asset increases future annual depreciation by EUR 9,400. Henriksen applies the adjustment prospectively from 1 January 2026 under IAS 16.61.
Documentation note: record the revised depreciable amount, the remaining useful life, and the recalculated annual depreciation charge. Confirm prospective treatment per IAS 8.36.
Conclusion: the decommissioning provision of EUR 3,230,000 is defensible because both the cost estimate and the discount rate rest on identifiable external sources, the IFRIC 1 adjustment flows correctly through the asset rather than profit or loss, and the depreciation impact is calculated prospectively.
Why it matters in practice
- Teams frequently fail to remeasure the provision when the cost estimate or discount rate changes. IFRIC 1.3 requires the entity to adjust the provision for changes in estimated cash flows or the discount rate, and to reflect that adjustment in the related asset (under the cost model) or in the revaluation surplus (under the revaluation model). Leaving a five-year-old cost estimate untouched on a 20-year obligation can understate the provision by 15% to 25% in an environment where remediation costs have risen.
- The discount rate used for unwinding is sometimes confused with the rate used for remeasurement. Under IFRIC 1.5(a), when estimated cash flows increase and the entity uses the cost model, the new cash flows are discounted at the current discount rate. The existing provision continues to unwind at the original rate until remeasured. Mixing these rates produces a provision balance that reconciles to neither the old estimate nor the new one.
Decommissioning obligation vs. restructuring provision
| Dimension | Decommissioning obligation (IAS 37 / IFRIC 1) | Restructuring provision (IAS 37.70–83) |
|---|---|---|
| Trigger | Legal or constructive obligation to dismantle or restore an asset, arising at initial recognition | Detailed formal plan to restructure, with a valid expectation created in those affected |
| Timing of recognition | At the same time as the related asset is recognised | When the entity has a detailed plan and has raised a valid expectation (IAS 37.72) |
| Asset linkage | Provision amount is capitalised as part of the related asset's cost under IAS 16.16(c) or IFRS 16.24(d) | No capitalisation; the full provision hits profit or loss immediately |
| Remeasurement treatment | Changes adjust the asset (cost model) or revaluation surplus (revaluation model) per IFRIC 1 | Changes adjust profit or loss directly |
| Typical duration | Long-dated (10 to 40 years for industrial sites, oil platforms, wind farms) | Short-dated (typically 12 to 24 months for workforce reductions or site closures) |
The distinction matters because decommissioning obligations create a paired asset-liability relationship that restructuring provisions do not. An auditor who tests a decommissioning provision without tracing the IFRIC 1 adjustment through to the asset side will miss a depreciation error that compounds over the remaining useful life.
Related terms
Frequently asked questions
How do I audit a decommissioning provision?
Obtain the cost estimate (typically from an independent engineer or environmental consultant) and evaluate whether the assumptions reflect current regulatory requirements and remediation technology. ISA 540.13(a) requires the auditor to assess whether the estimation method is appropriate. Test the discount rate against observable market data for obligations of similar duration and risk. Verify that IFRIC 1 adjustments have been applied to the correct side of the balance sheet.
Does a decommissioning obligation affect the right-of-use asset under IFRS 16?
Yes. When a lease contains a restoration obligation, IFRS 16.24(d) requires the estimated restoration cost to be included in the initial measurement of the right-of-use asset. The corresponding provision is still measured under IAS 37 and remeasured under IFRIC 1. The adjustment mechanics are the same: changes in the estimate adjust the right-of-use asset, not profit or loss.
When does the unwinding of discount go through profit or loss?
Every period. IAS 37.60 requires the increase in the provision caused by the passage of time to be recognised as a finance cost. This is not an operating expense. The unwinding charge grows each year as the provision balance increases, and it must be presented separately from operating costs in the income statement.