Question

On 01-01-15, G purchased a machine for $10,000,000. Installation costs incurred and paid for on 01-01-15 were $50,000. G started using the machine on 01-01-15. G estimates it will use the machine for 3 years. At the end of the 3rd year, G will have to dispose of the machine at an estimated cost of $435,000. Assume as of 01-01-15 the interest rate on US Treasury securities was 1.75% and G’s credit standing required a 2% risk premium. G uses a straight-line depreciation method and assumes no salvage value.

a. What amount should G report on its balance sheet as a fixed asset (machine) as of 12-31-15?

b. Prepare an excel spreadsheet that clearly identifies and clearly labels G’s ARO obligation balance as of 12-31 for every year from 2015 to 2017 AND G’s accretion expense for every year for 2015 to 2017.

c.Prepare the entries G should make related to the equipment and its ARO for the year ended 12-31-16 AND 12-31-17?

d. On 01-01-18, G paid a vendor $420,000 to dispose of the machine in accordance with current environmental regulations. Prepare the entry/entries G should make to record the disposal.

Answer 1

	Purchase price of machine	$10,000,000
	Add: Installation costs	$50,000			Calculation of present value of disposal cost
	Present value of disposal cost	$389,516			Disposal value at end of 3rd year			$435,000
		$10,439,516			Interest rate			3.75	%
	Useful life	3 years			Present value of interest factor(3years)			0.8954383
	Salvage value	$0				Present value		$389,516
	Depreciation per year	$3,479,839
a)	Value of fixed assets as on 12-31-15
	Machiery	$10,439,516
	Less: Accumulated depreciation	$3,479,839
	Reported in Balance sheet	$6,959,677
b)	G's ARO balance as of 31-12 of every year and finance cost is amount of accretion expense every year
	Date	Opening balance	Finance Cost (Opening balance*3.75%)	Closing balance
	12/31/2015	$389,516	$14,607.00	$404,123.00
	12/31/2016	$404,123	$15,155.00	$419,278.00
	12/31/2017	$419,278	$15,722.00	$435,000.00
c)	Journal entries
Date	Account titles and explanation	Debit	Credit
12/31/2016	Depreciation expense-machinery	$3,479,839
	Accumulated depreciation- machinery		$3,479,839
	(Depreciation for year 2 recorded)
12/31/2016	Finance Cost	$15,155
	To, Provision for ARO		$15,155
	(unwinding of interest)
12/31/2017	Depreciation expense-machinery	$3,479,839
	Accumulated depreciation- machinery		$3,479,839
	(Depreciation for year 3 recorded)
12/31/2017	Finance Cost	$15,722
	To, Provision for ARO		$15,722
	(unwinding of interest)
d)	Provision for ARO	$435,000
	Cash		$420,000
	ARO gain(Income statement)		$15,000
	(Being ARO obligations settled)