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%. Prepare the journal entry to record the asset retirement obligation (ARO) in January 2016 Prepare the journal entry to record the annual depreciation in 2016 and adjustment to the ARO. Prepare the 5-year amortization schedule for the ARO. 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

(a.) Oil platform project Dr.$1361470

  To Assets Retirement Obligation $1361470

Note:- Present value of expected cost at end of 5th year = 2000000 * 1 / (1 + 0.08)5 year

=2000000 * 1/ (1.08)5 year

   = 2000000 * 1/ 1.469

=$1361470

(b)

Depreciation expense Dr.$272294

To Accumulated depreciation $272294

Note:-   Depreciation expense per year =  1361470/5 year

= $272294

Finance cost Dr.$108918

To Assets Retirement Obligation    $108918

Note:- Finance cost per year =  $1361470 * 8%

=$108917.6

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