Question

Carla Mining Company recently purchased a quartz mine that it intends to work for the next 10 years. According to state environmental laws, Carla must restore the mine site to its original natural prairie state after it ceases mining operations at the site. To properly account for the mine, Carla must estimate the fair value of this asset retirement obligation. This amount will be recorded as a liability and added to the value of the mine on Carla’s books.

There is no active market for retirement obligations such as these, but Carla has developed the following cash flow estimates based on its prior experience in mining-site restoration. It will take 3 years to restore the mine site when mining operations cease in 10 years. Each estimated cash outflow reflects an annual payment at the end of each year of the 3-year restoration period.

Carla Mining Company recently purchased a quartz mine that it intends to work for the next 10 years. According to state environmental laws, Carla must restore the mine site to its original natural prairie state after it ceases mining operations at the site. To properly account for the mine, Carla must estimate the fair value of this asset retirement obligation. This amount will be recorded as a liability and added to the value of the mine on Carla's books. There is no active market for retirement obligations such as these, but Carla has developed the following cash flow estimates based on its prior experience in mining-site restoration. It will take 3 years to restore the mine site when mining operations cease in 10 years. Each estimated cash outflow reflects an annual payment at the end of each year of the 3-year restoration period. Restoration Estimated Cash Outflow $15,520 22,740 26,530 32,170 Probability Assessment 10% 30% 50% 10% Click here to view factor tables What is the estimated fair value of Carla's asset retirement obligation? Carla determines that the appropriate discount rate for this estimation is 5%. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to O decimal places, e.g. 458,581.) Estimated fair value of Carla's asset retirement obligation

Answer 1

Asset Retirement Cost: It is a cost which will be incurred when the asset is retired. The liability for the assets retirement cost should be recognised when the asset is acquired and it should be added the carrying value of the asset. It should be accounted at the present value of the obligation which will be incurred at the end of the life of assets and at each year interest expense will incurred every year and it will be added to the Asset Retirement Obligation account (A) Estimated Cash Outflow Probability (B) $15,520 10% $22,740 30% $26,530 50% $32,170 10% Total Estimated Cash flow for restoration Present Value $1, r = 5% and period 13 Present value of restoration cost $24856 x 0.53032] (A) x (B) $1,552 $6,822 $13,265 $3,217 $24,856 0.53032 $13,182 Estimated fair value of Carla's Asset Retirement obligation $13,182