Capitalising decommissioning, removal and site restoration obligations into the cost of Property, Plant and Equipment (PPE) under IAS 16 - key differences from VAS 03 and Circular 99

Enterprises that build factories on leased industrial-park land, install telecom base stations on leased land or rooftops, or develop wind and solar power farms — arrangements that typically include a clause to restore the site to its original condition upon expiry — typically give rise to a present obligation requiring future expenditure to dismantle the asset and restore the site. Under the regulations currently in force in Vietnam, when an obligation to dismantle an asset and restore the site meets the conditions for recognising a provision, the enterprise recognises a provision with the corresponding entry charged to expense, but does not capitalise this obligation into the cost of the asset; in practice, some entities may not fully recognise the provision and only record the expense when the obligation is settled at the end of the asset's life. Under IAS 16, the initial estimate of the costs of dismantling and removing the asset and restoring the site must be capitalised into the cost of the asset at initial recognition, giving rise to the recognition of a provision, higher depreciation expense, and a new finance cost recognised year after year.

Key conclusions

• The initial estimate of the costs of dismantling and removing an item of property, plant and equipment (PPE) and restoring the site on which it is located, arising from its construction or installation is capitalised into the cost of PPE (IAS 16.16(c)), with the corresponding entry recognised as a provision under IAS 37. Where the effect of the time value of money is material, the provision is measured at the present value of the estimated costs. The core difference from Vietnamese accounting requirements in this case is not whether a provision is recognised, but how the corresponding debit is accounted for: IFRS requires the obligation to be capitalised into the cost of the related asset, whereas Circular 99/2025/TT-BTC directs that the provision be recognised in expense.
• The obligation component included in cost is depreciated together with the asset over its useful life.
• The difference between the nominal amount payable in the future and the present value is recognised progressively over each period as a finance cost, known as the unwinding of the discount (IFRIC 1.8).
• When the estimated costs, the expected timing of settling the obligation, or the discount rate change, the enterprise adjusts the movement in the provision in accordance with IFRIC 1: under the cost model, the increase/decrease is adjusted by adding to/deducting directly from the cost of the asset (the carrying amount of the asset must not be reduced below zero, and any decrease in the obligation exceeding the carrying amount of the asset must be recognised immediately in profit or loss); under the revaluation model, the difference is dealt with through the revaluation surplus (OCI) or profit or loss depending on the specific circumstances.
• The portion of the obligation incurred when the asset is acquired or constructed, or an obligation incurred as a consequence of having used PPE during a period for purposes other than to produce inventories, is capitalised into the cost of PPE. The portion of the obligation incurred as a consequence of having used the asset to produce inventories (for example, a rehabilitation obligation that increases progressively with the volume of ore extracted) is recognised under IAS 2 and not capitalised into the cost of the asset.

Why does IAS 16 require decommissioning, removal and site restoration obligations to be capitalised into the cost of the asset?

IAS 16.16 provides that the cost of an asset comprises three groups of components: the purchase price; the costs directly attributable to bringing the asset to the condition and location necessary for it to be capable of operating; and — at point (c) — the initial estimate of the costs of dismantling and removing the asset and restoring the site on which it is located. The rationale lies in the nature of the obligation: if an enterprise has the right to place the asset at a location only on condition that it commits to dismantle the asset and restore the site when it leaves, then those dismantling and site-restoration costs are an inseparable part of the price paid to own and operate the asset. Recognising them in cost and depreciating them over the asset's life properly reflects that these costs are consumed in parallel with the economic benefits the asset provides.

The corresponding credit to the capitalised amount is a provision, measured under IAS 37: at the best estimate of the expenditure required to settle the obligation (IAS 37.36), and, where the effect of the time value of money is material, the provision is recognised at present value (IAS 37.45). The discount rate is a pre-tax rate that reflects the time value of money and the risks specific to the liability (IAS 37.47).

Because the provision is recorded at present value, it is lower than the nominal amount that will be payable at maturity. Year after year, as the settlement date approaches, the present value of the provision increases until it equals the nominal amount. The increase in each period is the unwinding of the discount, and is recognised as a finance cost (IFRIC 1.8).

An important boundary is set in IAS 16.18: a decommissioning or restoration obligation incurred because the asset was used to produce inventories during the period is not capitalised into the cost of PPE but recognised under IAS 2. In other words, an obligation that arises in full at installation (for example, once a wind turbine has been erected the entire dismantling obligation has arisen) is capitalised into the asset; an obligation that accumulates progressively with the level of activity (for example, the obligation to rehabilitate a mine increases with the volume already extracted) has its incremental portion in each period charged to production costs, which may become a component of the value of inventories.

Accounting for changes in the provision estimate under IFRIC 1: the cost model and the revaluation model

After initial recognition, the estimated value of the decommissioning or restoration obligation rarely stays the same. IFRIC 1.3 identifies three sources that change the value of the liability: changes in the estimated cash flows required to settle the obligation; changes in the current market-based discount rate (reflecting the time value of money and the risks specific to the liability); and the increase that arises from the passage of time, i.e. the unwinding of the discount. The unwinding of the discount is always recognised as a finance cost in the period (IFRIC 1.8) and is never adjusted against the cost of the asset. The other two sources — changes in the estimated cash flows and changes in the discount rate — are the subject of the adjustment mechanism described below, and when remeasuring, the enterprise uses the market discount rate at the date of remeasurement rather than retaining the original rate.

Where the cost model is applied:

The change in the provision is added to or deducted from the cost of the related asset (IFRIC 1.5). When the obligation increases (higher estimated costs or a lower discount rate), the increase raises the cost. An increase in cost is not, of itself, always an indicator of impairment; nevertheless, the enterprise must consider whether the increase is an indication that the new carrying amount of the asset may not be fully recoverable. If there is such an indication, the enterprise performs an impairment test under IAS 36 and recognises any impairment loss.

When the obligation decreases, the decrease is deducted from the cost, but the amount deducted must not exceed the carrying amount of the asset; if the decrease in the liability exceeds the carrying amount of the asset, the excess is recognised immediately in profit or loss. After the adjustment, the new carrying amount is depreciated prospectively over the remaining useful life.

Where the revaluation model is applied:

Under this model, a change in the provision is treated as a revaluation increase or decrease of the related asset and is recognised in other comprehensive income or profit or loss, as applicable, rather than being added to or deducted from the asset’s cost (IFRIC 1.6), because the carrying amount is presented at revalued amount. Adjusting cost for movements in the provision would cause the carrying amount to diverge from fair value — undermining the very nature of the revaluation model. IFRIC 1 therefore does not permit an adjustment to cost; instead, movements in the provision are recognised through the revaluation surplus mechanism of that asset.

When the obligation decreases, the decrease is recognised in other comprehensive income (OCI) and increases the revaluation surplus within equity; the exception is that the decrease is recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset that was previously recognised in profit or loss.

When the obligation increases, the increase is recognised in profit or loss; the exception is that the increase is charged against the revaluation surplus through OCI to the extent of the existing revaluation surplus balance of that asset.

In addition, if the decrease in the provision exceeds the carrying amount that would have been recognised had the asset been carried under the cost model, the excess is recognised immediately in profit or loss. A distinctive feature of the revaluation model: the fact that the provision has changed is itself an indication that the asset may need to be revalued so that its carrying amount does not differ materially from fair value at the reporting date; and if a revaluation is required, the entire class of assets to which it belongs must be revalued, not only that asset. Finally, the depreciable amount is adjusted and depreciated prospectively over the remaining life (IFRIC 1.7).

VAS vs IFRS comparison table

Illustrative example: constructing a factory on leased industrial-park land

Company A Ltd is an electronics-component manufacturer that builds a factory on leased land in an industrial park with a remaining lease term of 30 years. The lease contract requires Company A to dismantle the factory and return the site to its original condition at the end of the lease term. Unit: VND million.

The figures below are assumptions to illustrate the calculation mechanism:

• Date the factory is brought into use: 01/01/20X1.
• Cost of constructing the factory (excluding the dismantling obligation): 100,000.
• Estimated dismantling and site-restoration costs payable at the end of the lease term (future nominal value, after 30 years): 20,000. All of these costs relate directly to dismantling the factory built by Company A and remediating the effects of the factory’s construction on the site (excluding any obligation to restore the leased land that arises independently of the construction of the factory, or any obligation relating specifically to returning the underlying leased asset).
• Pre-tax discount rate: 8% per annum.
• Straight-line depreciation over 30 years, with the useful life matching the lease term.

Step 1 — Determine the present value of the obligation at the date of initial recognition

Present value = 20,000 ÷ (1.08)³⁰ = 1,988.

Step 2 — Determine the cost of the asset

PPE cost at initial recognition = 100,000 (construction cost) + 1,988 (dismantling obligation component) = 101,988.

Step 3 — Annual depreciation.

Annual depreciation = 101,988 ÷ 30 = 3,400, of which the portion attributable to the dismantling obligation component is 1,988 ÷ 30 = 66.

Step 4 — Unwinding-of-discount schedule

Journal entries in 20X1:

Initial recognition of the obligation component (01/01/20X1):

Dr PPE                                   101,988
Cr Trade payables/Cash     100,000
Cr Provision                          1,988

Depreciation for the full year 20X1:
Dr Depreciation expense                        3,400
Cr Accumulated depreciation - PPE     3,400

Unwinding of the discount in 20X1:
Dr Finance cost           159
Cr Provision                 159

When the estimate changes — applying IFRIC 1:

Suppose that at the end of 20X5, following an update of labour rates and dismantling equipment prices, Company A re-estimates the nominal amount payable in year 30 to increase from 20,000 to 26,000. The new present value of the obligation (25 years remaining) = 26,000 ÷ (1.08)²⁵ = 3,796. The provision balance currently recognised is 2,920. The difference of 3,796 – 2,920 = 876 is added to the cost of the asset under the cost model (IFRIC 1.5):

Dr PPE                  876
Cr Provision         876

Carrying amount of PPE after adjustment = (101,988 – 3,400 x 5) + 876 = 85,864, depreciated over the remaining 25 years, i.e. the annual depreciation charge from 20X6 onwards is adjusted to 85,864/25 = VND 3,435 million per year.

If the enterprise applies the revaluation model: the above increase in the estimate is recognised in profit or loss or first reduces the revaluation surplus (if there is a revaluation surplus balance) (IFRIC 1.6).

Adjustments on transition from VAS to IFRS and deferred income tax

Suppose Company A's date of transition to IFRS is 01/01/20X6, i.e. after 5 years of using the factory, and its financial statements previously prepared under VAS had not recognised any dismantling provision. To illustrate the transition entry in isolation, the original cost estimate of 20,000 is used here (assuming no change in estimate). The 8% rate is also assumed to be the best estimate of the appropriate historical discount rate throughout the entire 20X1–20X5 period.

IFRS 1 provides an optional exemption that allows a simplified measurement approach, avoiding the need to reconstruct the entire history of IFRIC 1 adjustments from the date the obligation arose (IFRS 1.D21): the enterprise measures the provision at the date of transition under IAS 37, then discounts that provision back to the date the obligation first arose to estimate the amount that should have been capitalised into cost, and then computes accumulated depreciation on that basis.

• Provision at 01/01/20X6 (25 years remaining) = 20,000 ÷ (1.08)²⁵ = 2,920.
• Discounting this provision back to the date it arose (01/01/20X1) = 2,920 ÷ (1.08)⁵ = 1,988. This is the obligation component that should have been capitalised into cost.
• Accumulated depreciation of this component after 5 years = 1,988 × 5 ÷ 30 = 332. Carrying amount = 1,656.
• Effect on retained earnings = − 2,920 (recognising the liability) + 1,656 (carrying amount of the asset component) = − 1,264.

The figure reducing retained earnings by 1,264 is precisely the sum of two parts: the finance cost from the unwinding of the discount accumulated over 5 years (VND 932 million) and the accumulated depreciation of the obligation component (VND 332 million).

Transition adjustment entry (at 01/01/20X6):

Dr PPE                                                       1,988

Dr Retained earnings                               1,264

Cr Accumulated depreciation - PPE      332

Cr Provision                                               2,920

Deferred income tax:

Suppose the tax authority only allows the expense when it is actually paid. The above adjustment creates two temporary differences. The provision of VND 2,920 million has a carrying amount greater than its tax base of nil, creating a deductible temporary difference that gives rise to a deferred tax asset. The obligation component within the cost of the asset (carrying amount of VND 1,656 million) has a carrying amount greater than its tax base of nil, creating a taxable temporary difference that gives rise to a deferred tax liability.

With an assumed corporate income tax rate of 20%:

• Deferred tax asset = 2,920 × 20% = 584.
• Deferred tax liability = 1,656 × 20% = 331.

Recognising the full deferred tax asset of 584 assumes that the enterprise expects to have sufficient future taxable profit to utilise the deduction when the obligation is settled.

Deferred tax transition adjustment entry (at 01/01/20X6):

Dr Deferred tax asset            584

Cr Deferred tax liability         331

Cr Retained earnings            253

After accounting for deferred tax, the net effect on retained earnings at the date of transition from this adjustment alone is − 1,264 + 253 = − VND 1,011 million.

Common errors and practical difficulties when implementing in Vietnam

Using the future nominal value as the provision. Recognising 20,000 straight away as the provision instead of the present value of 1,988, results in incorrect initial measurement and a failure to recognise finance costs from the unwinding of the discount over the relevant periods.

Confusing an installation-related obligation with a production-related obligation. For mines, waste landfills or the ash-and-slag ponds of thermal power plants, part of the rehabilitation obligation increases progressively with the volume extracted or landfilled. This part is not added to the cost of PPE but is recognised in production costs of the period under IAS 2 and IAS 37; only the portion of the obligation that arises in full at initial construction, or an obligation incurred as a consequence of having used PPE during a period for purposes other than to produce inventories is capitalised under IAS 16.16(c). Mixing these two parts distorts both the cost of the asset and the value of inventories.

Choosing the wrong discount rate and failing to update estimates. The discount rate must be a pre-tax rate reflecting the risks specific to the liability; using an arbitrary rate distorts both the provision and the capitalised component. In addition, the cost estimate and the rate must be reviewed and updated across periods under IFRIC 1; skipping this step causes the provision balance to drift progressively away from reality.

Equating an environmental-remediation deposit with the obligation provision. Vietnamese environmental law requires certain enterprises to place a deposit for environmental improvement and rehabilitation. This deposit is an amount the enterprise pays out and has the right to recover — in substance an asset. The dismantling and rehabilitation obligation is a liability. The two items are recognised and presented separately and must not be offset; combining them would misstate both assets and liabilities in the statement of financial position.

Frequently asked questions

Does Circular 99 require this obligation to be estimated and a provision to be recognised? Circular 99 permits provisions for environmental rehabilitation, clean-up, restoration and the return of a site to be recognised in Account 352, determined in accordance with VAS 18, and for lease contracts that contain a site-restoration clause the enterprise is also permitted to recognise a provision. However, the provision is charged to expense, unlike IFRS which mandates capitalisation into the cost of the asset.

In Vietnam, how is the discount rate for a decommissioning, removal and site-restoration obligation determined? IAS 37 requires a pre-tax rate that reflects the time value of money and the risks specific to the liability. In practice, an entity may start with a risk-free rate based on yields on Vietnamese Government bonds with a maturity comparable to the remaining term of the obligation and adjust it for relevant liability-specific risks. This is an estimate that requires professional judgement and whose assumptions need to be clearly disclosed.

Determining the scope of the obligation, estimating future costs, selecting the discount rate and dealing with deferred tax all require judgement and data specific to each enterprise. Our IFRS conversion advisory team can help enterprises review review their portfolio of lease contracts and assets subject to decommissioning or restoration obligations, build the calculation model and prepare appropriate transition entries.

This article has been prepared solely to provide general information and technical guidance, and does not constitute accounting, audit, tax or legal advice for any specific transaction or entity. The figures, assumptions and journal entries in the article are illustrative only and should be adjusted to actual circumstances, professional judgement and the records of each enterprise. We accept no responsibility for any loss arising from the use of the information in this article without appropriate professional advice. For support with a specific situation, please contact our IFRS conversion advisory team.