Accounting for the effect of changes in the discount rate
A provision is required to be set up for an expected cash outflow of €100,000 (estimated at current prices), payable in three years’ time. The appropriate nominal discount rate is 7.5%, and inflation is estimated at 5%. At future prices the cash outflow will be €115,762 (€100,000 × 1.053). The net present value of €115,762, discounted at 7.5%, is €93,184 (€115,762 × 1 ÷ (1.075)3).
At the end of Year 2, all assumptions remain valid, except it is determined that a current market assessment of the time value of money and the risks specific to the liability would require a decrease in the discount rate to 6.5%. Accordingly, at the end of Year 2, the revised net present value of €115,762, discounted at 6.5%, is €108,697 (€115,762 ÷ 1.065).
The movement in the provision would be reflected as follows:
|
Undiscounted € |
Provision € |
|
|
Year 0 |
115,762 |
93,184 |
|
Unwinding of discount (€93,184 x 0.075) |
6,989 |
|
|
Revision to estimate |
– |
|
|
Year 1 |
115,762 |
100,173 |
|
Unwinding of discount (€100,173 x 0.075) |
7,513 |
|
|
115,762 |
107,686 |
|
|
Revision to estimate (€108,697 – €107,686) |
1,011 |
|
|
Year 2 |
115,762 |
108,697 |
|
Unwinding of discount (€108,697 x 0.065) |
7,065 |
|
|
Revision to estimate |
– |
|
|
Ycar 3 |
115,762 |
115,762 |
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