Question

On January 1, 2X01, Big Oil placed in service an offshore oil platform that it constructed. Big Oil is legally required to dismantle and remove the platform at the end of its 10-year estimated life. Using expected present value techniques, Big Oil recorded an estimated asset retirement obligation (ARO) of $100,000 on January 1, 2X01. The ARO measurements on January 1, 2X01, are as follows:Expected cash flow before inflation: $190,000Expected cash flow adjusted for inflation and market risk: $220,000Present value using credit-adjusted risk-free rate: $100,000Assuming that the ARO is settled on December 31, 2X10, for $170,000, what is the gain or loss on the settlement?A. $70,000 lossB. $20,000 gainC. $50,000 gainD. No gain or loss

Answer 1

$ 50,000 is the gain on the settlement

Step-by-step explanation:

Given:

The estimated asset retirement obligation (ARO) = $ 100,000

Expected cash flow before inflation = $ 190,000

Expected cash flow adjusted for inflation and market risk = $220,000

Now,

gain (or) loss on the settlement of the ARO liability

= ARO liability - the actual settlement cost

on substituting the respective values, we get

gain or loss on the settlement of the ARO liability = $ 220,000 - $ 170,000

or

gain or loss on the settlement of the ARO liability = $ 50,000

Also,

Since, the initial liability is to be increased to the expected cash flow

therefore, it $ 50,000 is the gain on the settlement