End-Of-Chapter Material

Chapter 12 - SFAS. No. 143

Chapter 12

End-of-Chapter Material Relating to SFAS. No. 143

QUESTION:

1. What is an asset retirement obligation? What is the proper accounting for an asset retirement obligation?

PRACTICE 1 ACCOUNTING FOR AN ASSET RETIREMENT OBLIGATION

The company purchased a mining site that will have to be restored to certain specifications when the mining production ceases. The cost of the mining site is $800,000, and the restoration cost is expected to be $200,000. It is estimated that the mine will continue in operation for 15 years. The appropriate interest rate is seven percent. Make the appropriate journal entries to record the purchase of the mining site and the recognition of the obligation to restore the mining site.

Exercise 1 asset retirement obligation

Simpson Company purchased a nerve gas detoxification facility. The facility cost $900,000. The cost of cleaning up the routine contamination caused by the initial location of nerve gas on the property is estimated to be $1,300,000; this cost will be incurred in 20 years when all of the existing stockpile of nerve gas is detoxified and the facility is decommissioned. Additional contamination will occur each year that the facility is in operation. In its first year of operation, that additional contamination adds $100,000 to the estimated cleanup cost, which will occur after 19 years (because one year has elapsed). Make the journal entries necessary to record the purchase of the detoxification facility and the recognition of the initial asset retirement obligation (assuming that the appropriate interest rate is 7 percent). Also make the journal entry to recognize the additional obligation created after one year.

Problem 1 ASSET RETIREMENT OBLIGATION

Burns Company has purchased land that will serve as a temporary repository for nuclear waste. The site will function for 30 years, at which time Burns will be required to completely decontaminate the land. The purchase price for the land is $500,000. Burns knows that the land will have to be decontaminated, but isn’t sure which of several possible approaches will be sufficient to reach the level of decontamination necessary by law. The costs of each approach, and the estimated probability that the approach will be the one used, are given below:

Approach 1 10% probability of total decontamination cost of $5,000 at the end of 30 years.

Approach 2 20% probability of total decontamination cost of $100,000 at the end of 30 years.

Approach 3 70% probability of total decontamination cost of $1,500,000 at the end of 30 years.

The appropriate interest rate is 8 percent.

Instructions:

Make the journal entries necessary to record the purchase of the land and the recognition of the asset retirement obligation.

7. How does the recognition of an asset retirement obligation impact periodic depreciation expense? Interest expense?