7 – Decommissioning Costs

Problems with Solutions

Problems 7-1 and 7-2 (in this document). These two problems should be enough and are
indicative of how you could be tested on this material in this course.
Problem 7-1
On December 31, 20x5 you install a septic field costing $200,000. The expected useful
life of the septic field is 20 years after it will have to be replaced. The replacement will
require a complete decontamination of the soil. The expected cost to decontaminate the
soil is $130,000. The relevant discount rate is 5%. Your year end is December 31.
a) Prepare the journal entries relative to this project for the first two years.
b) During 20x20, you estimate the land decontamination costs to be $180,000 and
the estimate of the discount rate changed to 4%. Prepare all journal entries relative
to this project for the year 20x20.
c) Because of high than expected use, you have to replace the septic field in January
20x22. The actual cost of decontaminating the land was $195,000.

Problem 7-2

A publicly accountable entity spent a total of $35,000,000 to set up a mining operation in

northern Ontario during 20x0. The mine started operations on January 2, 20x1 and is
expected to operate for a total of 25 years. At the end of its useful life, the property will
have to be restored. At December 31, 20x0, management’s best estimate of the cost of
decommissioning the mine in 20x26 is $15,000,000. Assume a discount rate of 6%.

Required –

(a) Prepare the journal entries to reflect the above transactions for 20x0, 20x1 and
20x2.
(b) During 20x6, the estimate of the decommissioning costs changes to $20,000,000.
Prepare all journal entries related to the mining property for 20x6.
(c) During 20x24, because of advances in technology, the decommissioning costs are
now estimated to be $5,000,000. Prepare all journal entries related to the mining
property for 20x24 and 20x25.
SOLUTION

Problem 7-1
(a) PV of ARO:

N I/Y PV PMT FV
Enter 20 5 130,000
Compute 48,996

Dec 31, 20x5 Septic field $248,996

Cash $200,000
Asset Retirement Obligation 48,996

Dec 31, 20x6 Depreciation expense 12,450

Accumulated depreciation 12,450
$248,996 / 20

Interest expense 2,450

Asset retirement obligation 2,450
$48,996 x 5%

Dec 31, 20x7 Depreciation expense 12,450

Accumulated depreciation 12,450

Interest expense 2,572

Asset retirement obligation 2,572
($48,996 + 2,450) x 5%

(b) PV of existing ARO at beginning of 20x20:

N = 6, I = 5, FV = 130,000
PV = 97,008

PV of revised ARO at beginning of 20x20:

N = 6, I = 4, FV = 180,000
PV = 142,257

Increase in ARO = $45,249

Carrying value of asset at beginning of 20x20:

$248,996 x 6 / 20 = $74,699

New carrying value = $74,699 + 45,259 = 119,958

 Beg 20x20 Septic Field 45,249
Asset Retirement Obligation 45,249

Dec 31, 20x20 Interest expense 5,690

ARO 5,690
$142,257 x 4%

Depreciation expense 19,993

Accumulated depreciation 19,993
$119,958 / 6

(c) PV of ARO at Dec 31, 20x21

N = 4, I = 4, FV = 180,000
PV = 153,865

Carrying value of asset at Dec 31, 20x21

$119,958 x 4/6 = 79,972

Jan 20x22 Asset Retirement Obligation 153,865

Accumulated Depreciation 214,273
Loss on decommissioning 121,107
Septic Field 294,245
Cash 195,000
Problem 7-2

(a) Present Value of ARO:

N = 25 I = 6 FV = $15,000,000
PV = 3,494,979

Dec 31, 20x0 Mine $38,494,979

Cash $35,000,000
Asset Retirement Obligation 3,494,979

Dec 31, 20x1 Interest expense 209,699

Asset Retirement Obligation 209,699
$3,494,979 x 6%

Depreciation expense 1,539,799

Accumulated depreciation 1,539,799
$38,494,979 / 25

Dec 31, 20x2 Interest expense 222,281

Asset Retirement Obligation 222,281
($3,494,979 + 209,699) x 6%

Depreciation expense 1,539,799

Accumulated depreciation 1,539,799

(b) PV of ARO at the beginning of 20x6 becomes:

N = 20 I = 6 FV = 20,000,000
PV = $6,236,095

PV of ARO using original estimates:

N = 20 I = 6 FV = 15,000,000
PV = $4,677,071 Increase of $1,559,024

NBV of mine at beginning of 20x6: $38,494,979 x 20/25 = $30,795,983

Jan 2, 20x6 Mine $1,559,024

Asset retirement obligation $1,559,024

Dec 31, 20x6 Interest expense 374,166

Asset retirement obligation 374,166
$6,236,095 x 6%

Depreciation expense 1,617,750

Accumulated depreciation 1,617,750
($30,795,983 + 1,559,024) / 20
= 32,355,007 / 20
(c) PV of ARO at the beginning of 20x24 becomes:
N = 2 I = 6 FV = 5,000,000
PV = $4,449,982

PV of ARO using revised 20x6 estimates:

N = 2 I = 6 FV = 20,000,000
PV = $17,799,929 Decrease of $13,349,947

Net book value of mine at beginning of 20x24:

$32,355,007 x 2/20 = $3,235,500

Jan 2, 20x24 ARO $13,349,947

Accumulated depreciation 36,818,503
Mine 40,054,003
Gain on revision of ARO 10,114,447

Dec 31, 20x24 Interest expense 266,999

Asset Retirement Obligation 266,999
$4,449,982 x 6%

Dec 31, 20x25 Interest expense 283,019

Asset Retirement Obligation 283,019
($4,449,982 + 266,999) x 6%