Question

On January 1, 2019, Barbosa Company purchased a coal mining site for $1,000,000. Under the terms of the purchase agreement, Barbosa must restore the site to specified conditions at an estimated cost of $125,000. Barbosa estimates that it will be able to operate the site for 20 years. Barbosa uses a 6% discount rate.

I am having trouble calculating the cost of the asset retirement obligation.

Answer 1

Explanation:

To calculate the cost of the asset retirement obligation (ARO), you will need to determine the present value of the estimated future cash flows required to settle the obligation.

In this case, the estimated cost to restore the coal mining site is $125,000, and Barbosa estimates that it will be able to operate the site for 20 years. We will assume that the restoration cost is incurred at the end of the 20th year.

To calculate the present value of the ARO, you can use the following formula:

Present Value of ARO = ARO Amount / (1 + Discount Rate)^n

Where ARO Amount is the estimated cost to restore the site, Discount Rate is the rate at which the future cash flows are discounted (in this case, 6%), and n is the number of years until the ARO will be settled (in this case, 20).

Using this formula, we can calculate the present value of the ARO as follows:

Present Value of ARO = $125,000 / (1 + 0.06)^20

= $41,198.31

Therefore, the cost of the asset retirement obligation is $41,198.31. This amount should be recorded as a liability on Barbosa's balance sheet and amortized over the 20-year estimated life of the mining site.