How Decommissioning Liabilities Are Estimated and Unwound Over Time Under IAS 37

Decommissioning liabilities—also known as asset retirement obligations—arise when an entity is required to dismantle, remove, restore, or rehabilitate an asset or site at the end of its useful life. Under IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, these obligations must be recognized at present value when the obligation is created and subsequently unwound over time through the recognition of the unwinding of the discount (accretion expense).

Industries with major decommissioning requirements include oil & gas, mining, energy, utilities, chemical processing, and heavy manufacturing. Because these obligations may involve cash outflows decades into the future, the estimation methodology, discount rate selection, inflation expectations, and periodic reassessment have a significant impact on profit, assets, and equity.

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Decommissioning liabilities arise when an entity has a legal or constructive obligation to restore a site or dismantle an asset at the end of its use.

A decommissioning liability must be recognized when:

• The entity uses an asset that will require dismantling or site restoration

• A legal requirement exists (permits, contracts, regulations)

• A constructive obligation arises from past practices or commitments

• The obligation is tied to an asset’s current condition, not future operations

Examples include:

• Oil platforms requiring full removal and seabed restoration

• Mines requiring backfilling and environmental remediation

• Nuclear sites with radioactive material management

• Chemical plants requiring land detoxification

• Renewable energy farms with turbine removal obligations

The obligation is recognized when the asset is installed or developed, not when decommissioning activities occur—sometimes decades later.

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IAS 37 requires the initial measurement of decommissioning liabilities at present value, combined with capitalization of the corresponding asset retirement cost.

Initial measurement involves:

• Estimating the future cash outflows required for dismantling

• Adjusting estimates for inflation

• Discounting the inflated cash flows to present value using a pre-tax discount rate that reflects current market assessments

• Recognizing a provision for the liability

• Capitalizing a corresponding amount as part of the cost of the related asset

This creates two accounting components:

1. A liability, measured at present value

2. An increase in the asset’s carrying amount, depreciated over its useful life

This process ensures that the entity recognizes the cost of decommissioning over the life of the asset rather than at the end.

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Core Components of Decommissioning Liability Valuation

Component	Description
Future Cash Outflows	Direct dismantling, restoration, disposal, monitoring costs
Inflation Adjustment	Escalation of costs over the obligation horizon
Discount Rate	Pre-tax, risk-adjusted, reflecting time value of money
Provision Recognition	Present value of obligation recognized as liability
Asset Capitalization	Increase in asset cost, depreciated over useful life
Periodic Remeasurement	Adjust for discount rate changes, updated estimates

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Over time, the liability must be unwound, creating interest-like accretion expense recognized in profit or loss.

IAS 37 requires the liability to be:

• Accreted annually (unwinding of discount)

• Recognized as finance expense

• Increased at each reporting date to reflect the passage of time

This finance expense represents the growth in the present value of the liability as settlement approaches.

Journal entry for unwinding:

• Debit: Finance Expense – Unwinding of Discount

• Credit: Decommissioning Liability

Entities must reassess:

• Expected timing of cash flows

• New estimates of dismantling or remediation costs

• Changes in inflation rates

• Changes in discount rates

• Regulatory or environmental developments

Significant estimation changes require remeasurement of both the liability and the related asset.

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Journal entries demonstrate initial recognition, accretion, remeasurement, and settlement of decommissioning liabilities.

Initial recognition

• Debit: Property, Plant & Equipment (Asset Retirement Cost)

• Credit: Decommissioning Liability (Present Value)

Unwinding of discount

• Debit: Finance Expense

• Credit: Decommissioning Liability

Remeasurement (increase in estimate)

• Debit: Property, Plant & Equipment

• Credit: Decommissioning Liability

Remeasurement (decrease in estimate)

• Debit: Decommissioning Liability

• Credit: Property, Plant & Equipment / Profit or Loss (depending on asset balance)

Settlement at end of asset life

• Debit: Decommissioning Liability

• Credit: Cash

Entities using IFRIC 1 must also adjust the asset’s carrying amount for remeasurements, except where the asset is already fully depreciated.

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Decommissioning liabilities materially affect balance sheets, depreciation, profit, cash flows, and equity over long horizons.

Key financial statement impacts:

• Higher asset values due to capitalized retirement costs

• Higher depreciation expense over time

• Higher finance costs due to unwinding of discount

• Large liability balances that grow as settlement nears

• Equity volatility when discount rates or cost estimates change

• Potential impairment triggers when liability assumptions rise sharply

Analysts watch for:

• sensitivity to discount rate movements

• rising environmental obligations

• regulatory changes affecting cost estimates

• maturity mismatch between liability timing and asset useful life

• liquidity planning for long-term obligations

For long-horizon industries (e.g., nuclear), balance sheet leverage is heavily influenced by this provision.

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Operational challenges include estimation accuracy, regulatory uncertainty, environmental risk modeling, and long-term governance across decades.

Common difficulties:

• Obtaining long-term cost estimates in volatile regulatory environments

• Predicting inflation decades into the future

• Aligning decommissioning practices with environmental laws

• Modeling discount rates across economic cycles

• Ensuring consistent treatment across global sites

• Documenting assumptions for audit and regulatory review

• Tracking assets that may operate for 30–50 years

• Managing disputes among joint-venture partners for shared sites

Entities must maintain long-term records, risk models, and compliance structures that often exceed the life cycles of management teams.

Accurate modeling and transparent reporting of decommissioning liabilities ensure that long-term environmental and contractual obligations are faithfully represented, supporting responsible governance and asset stewardship.

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