Asset Retirement Obligations
Lesson:
Capital assets don't usually go away.
Sometimes you can sell them for a profit.
In other cases, you have to pay to shut them down.
Think about a hazardous materials site or a junkyard. Shutting down either of them would require significant expenditures to make them safe.
Fortunately, we can often predict how much these closing activities will cost. As a result, we can record an estimated cost when we stick the assets on our books and then track the expense incurred each year.
You're an accountant, trying to explain an asset retirement obligation to a firm's owner.
You've been provided with the following information:
- The future value is $87,000.00.
- The discount rate is 14%.
- The time until retirement is 4 years.
- The present value is $51,510.98.
What are the journal entries that need to be added at the end of each year for the balance sheet (use the straight-line method)?
Answer:
-
End of year J/E for ARO Depreciation Expense $12,877.75 Accumulated Depreciation $12,877.75 Interest Expense $7,211.54 AssetRetirementObligation $7,211.54
Explanation:
- Since we're assuming straight-line depreciation, divide the total ARO by the number of years.
YEARLY DEPRECIATION = $51,510.98 / 4 -
End of year J/E for ARO Depreciation Expense $12,877.75 Accumulated Depreciation $12,877.75 - Now we need to adjust for the discount. To do this, we multiply the discount rate by the present value of the ARO.
INTEREST EXPENSE = 14.00% * $51,510.98 -
End of year J/E for ARO Depreciation Expense $12,877.75 Accumulated Depreciation $12,877.75 Interest Expense $7,211.54 AssetRetirementObligation $7,211.54