Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and

Question

Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and development costs totaled $7.5 million. After the silver is extracted in approximately five years, Smithson is obligated to restore the land to its original condition, including constructing a wildlife preserve. The company’s controller has provided the following three cash flow possibilities for the restoration costs: (1) $690,000, 20% probability; (2) $740,000, 50% probability; and (3) $840,000, 30% probability. The company’s credit-adjusted, risk-free rate of interest is 7%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

1) What is the carrying value of the asset retirement liability at the end of one year?

2) Assuming that the actual restoration costs incurred after extraction is completed are $786,000, what amount of gain or loss will Smithson recognize on retirement of the liability?

Smithson Mining operates a silver mine in Nevada. Acquisition, exploration, and development costs totaled $7.5 million. After the silver is extracted in approximately five years, Smithson is obligated to restore the land to its original condition, including constructing a wildlife preserve. The company’s controller has provided the following three cash flow possibilities for the restoration costs: (1) $690,000, 20% probability; (2) $740,000, 50% probability; and (3) $840,000, 30% probability. The company’s credit-adjusted, risk-free rate of interest is 7%. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

1) What is the carrying value of the asset retirement liability at the end of one year?

2) Assuming that the actual restoration costs incurred after extraction is completed are $786,000, what amount of gain or loss will Smithson recognize on retirement of the liability?

Explanation / Answer

Expected Fair Value of Asset retirement Obligation Expected Value 7,60,000.00 Amount Probability 6,90,000.00           0.20 1,38,000.00 7,40,000.00           0.50 3,70,000.00 8,40,000.00           0.30 2,52,000.00 Expected Value 7,60,000.00 Company’s credit-adjusted, risk-free rate of interest                 0.07 PVF at the end of 5th Year                 0.71 Present Value(Fair Value) 5,41,869.50 Initial Recognition of ARO 5,41,869.50 Ans 1 Subsequent measurement at the end of 1st year 5,79,800.36 Ans 2 Actual Retirement Liability 7,86,000.00 Book Value of ARO at the end of 5 years 7,60,000.00 Loss on Retirement of ARO      26,000.00

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