Question

Big Cat Exploration erected an oil platform in a remote area of Texas at a cost of $10 million. Bit Cat is legally required to dismantle and remove the platform at the end of its useful life, which is expected to be 10 years. Big Cat estimates that the cost of dismantling and removing the oil rig will be $700,000. Assume that the appropriate discount rate is 8%. Required: Prepare the journal entry to record the acquisition of the oil platform.

Answer 1

The $700,000 is an expense that will be incurred in 10 years from now. It howveer, needs to be accounted for in the present to show cost.

With a discount rate of 8% and 10 years as the period, the PV is,

= 700,000 / ( 1 + r) ¹⁰

= 700,000 / 1.08 ¹⁰

= 324,235.441659

= $324,235

Journal Entry becomes.

DR Oil Platform $10,324,235

CR Cash $10,000,000

CR Asset Retirement Obligation $324,235

(To record Oil Platform Acquisition)