In January 2016, Deep Sea Oil Inc. builds and begins operating an oil drilling p

Question

In January 2016, Deep Sea Oil Inc. builds and begins operating an oil drilling platform in the Gulf of Mexico. The company expects to operate the platform for 5 years and will be required to remove the platform at the end of 5 years at an expected cost of $2,000,000. Assuming that the discount rate is 8%. Show all work

a. Prepare the journal entry to record the asset retirement obligation (ARO) in January 2016

b. Prepare the journal entry to record the annual depreciation in 2016 and adjustment to the ARO.

c. Prepare the 5-year amortization schedule for the ARO.

d. Assume that at the end of 5 years, it costs the company $2,125,000 to remove the platform. Prepare the entry (assume payment is in cash).

Explanation / Answer

Present value of the expected cost at the end of 5 years = expected cost/discounting factor of 5 years @8%

= $2000000/ (1.08)5 = $1361166

So annual contribution to assets retirement obligation = 1361166/5 = $272233

Journal Entries:

a. Asset Retirement obligation a/c Dr. 272233   

To provision for ARO 272233

b. Depreciation a/c Dr.   

To Platform

ARO a/c Dr.

To Depreciation

c. Amortisation schedule of ARO will be  as follows:

*the value is less than $2000000 because of the rounding off

d. Provision for ARO Dr. 1724850

Loss on removal dr. 400150

To Cash 2125000

Year Opening balance Addition during the year Interest capitalisation Closing Balance 1 -- 272233 21779 294012 2 294012 272233 45300 611545 3 611545 272233 70702 954480 4 954480 272233 98137 1324850 5 1324850 272233 127767 1724850*

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