Reference no: EM133000619

Genovate acquired a subsidiary, Creogen, on 31 December 20X3. As part of the acquisition, Genovate assumed a decommissioning liability and is required to measure it at fair value. Creogen has to decommission a generating plant at the end of its useful life, which is in three years' time.

The directors are unsure how the liability should be measured, but have decided that a valuation technique will be required. They have provided the following information on the assumption that Genovate is allowed to transfer the liability to another market participant.

• Labour, material and overhead costs to decommission the plant are $3.75 million.
• Third party contractors in the industry typically add a 30% mark-up and expect a premium of 5% of the expected cash flows (after including the effect of inflation) to take into account the risk that cash flows may be more than expected.
• Inflation is expected to average 4% annually over the three years.
• The risk-free interest rate for a three-year maturity is 3%. An appropriate adjustment to the risk-free rate for Genovate's non-performance risk is 2%.

Required

Problem 1: Explain to the directors of Genovate how the fair value of the decommissioning liability should be determined in accordance with International Financial Reporting Standards, with reference to the requirements of IFRS 13 Fair Value Measurement.