Question

A company buys an oil rig for $2100000 on January 1, 2018. The life of the rig is 10 years and the expected cost to dismantle the rig at the end of 10 years is $605000 (present value at 12% is $194800). 12% is an appropriate interest rate for this company. What expense should be recorded for 2018 as a result of these events

Answer 1

Depreciation = $229,480

Interest expense = $23,376

Step-by-step explanation:

The cost of an asset includes the cost of purchase , every other cost involved in putting it to use and also the cost of dismantling , removing and restoring the site on which it is located.

However , it is the present value of the dismantling cost that is calculated while the related finance cost if charged to the expenses account.

In the given scenario , the two expenses involved are depreciation and the finance charges on the present value of the dismantling cost.

Depreciation expense

Price = 2,100,000

Dismantling cost = 194,800

Total cost =2,294,800

Useful life = 10 years

Depreciation = 2,294,800/ 10 =$229,480

Finance cost

Present value = 194,800

Interest rate = 12%

Interest expense = $23,376