Nette, a public limited company, manufactures mining equipment and extracts natural gas.! The directors are uncertain about the role of the lASB's Framework for the Preparation and Presentation of Financial Statements (i.e. the Framework) in corporate reporting. Their view is that accounting is based on the transactions carried out by the company and that these transactions are allocated to the company's accounting period by using the matching and prudence concepts. The argument put forward by the directors is that the Framework does not take into account the business and legal constraints within which companies operate. Further, they have given a situation which has arisen in the current financial statements where they feel that the current accounting practice is inconsistent with the Framework.
Situation Nette has recently constructed a natural gas extraction facility and commenced production one year ago (1 June 2003). There is an operating licence given to the company by the government which requires the removal of the facility at the end of its life which is estimated at 20 years. Depreciation is charged on the straight line basis. The cost of the construction of the facility was $200 million and the net present value at 1 June 2003 of the future costs to be incurred in order to return the extraction site to its original condition is estimated at $50 million (using a discount rate of 5% per annum). 80% of these costs relate to the removal of the facility and 20% relate to the rectification of the damage caused through the extraction of the natural gas. The auditors have told the company that a provision for decommissioning has to be set up.
Required:
(a) Explain the importance of the Framework to the reporting of corporate performance and whether it takes into account the business and legal constraints placed upon companies.
(b) (i) Explain, with reasons and suitable extracts/computations, the accounting treatment of the above situation in the financial statements for the year ended 31 May 2004.
(ii) Discuss whether the treatment of the items appears consistent with the Framework.