Use of discounting and tax effect
It is estimated that the settlement of an environmental provision will give rise to a gross cash outflow of £500,000 in three years time. The gross interest rate on a government bond maturing in three years time is 6%. The tax rate is 30%.
The net present value of the provision is £419,810 (£500,000 × 1 ÷ (1.06)3). Hence, a provision of £419,810 should be booked in the balance sheet. A corresponding deferred tax asset of £125,943 (30% of £419,810) would be set up if it met the criteria for recognition in IAS 12.