Question

On July 1, 2020, Samuel Oil International Ltd. purchased a drilling rig, expecting to operate the rig for 3 years. At the end of this 3 year period, Samuel Oil is legally required to dismantle the rig and remediate the land. Samuel Oil follows IFRS. Other information pertaining to this purchase follows: $ 143,307 5% 1,251,861 $ Estimated cost to dismantle the rig and remediate the land in 3 years Estimated discount rate Cost of the drilling rig on July 1, 2020 At the end of the drilling rig's 3-year life, it was dismantled and the land was remediated at an actual cost of: Samuel Oil's year end 150,472 November 30, 2020 Required: 1. Record the journal entries at July 1, 2020 for: (a) the cost of the drilling rig; and (b) the obligation to dismantle the rig and remediate the land. 2. Record the adjusting journal entry pertaining to the asset retirement obligation at the end of the 2020 fiscal year end. 3. Record the adjusting journal entry at the 2020 fiscal year end for depreciation expense. Assume that Samuel Oil uses the straight-line method of depreciation and that the drilling rig does not have any estimated residual value at the end of its useful life. 4. Record the journal entry for the payment of the asset retirement obligation at the end of the rig's useful life.

Answer 1

1) Record the Journal Entries at 01st July, 2020 for (as per IFRS)

a) the cost of the drilling rig - and (b) the obligation to dismantly the rig and remediate the land

Answer a) As per IAS 16 (Property , Plant and equipment) the cost of Asset includes

1) Purchase price of the asset including any import duties, brokerage etc paid after deducting any discounts received.

2) Any type of cost incurred to bring the asset to its present location and condition including transportation etc.

3) the initial estimate of cost of dismantling of the asset at the end of its useful life.

Since there is no residual value of the oil rig hence, the entire cost would be depreciated over its useful life of 3 years.

Cost of Purchase of an Asset = Purchase Cost + PV of Decommissiong Cost

However, since the cost of 143307 needs to be incurred at the end of 3 years so we need to find its present value. The present value of this liability will be included in the cost of the Asset (i.e. Oil Rig) by using the formula

PV(Present Value) = Future Value/(1+r)^n

PV = 143307/(1+5%)^3 =123,793.97

Cost of Oil Rig = 1,251,861+123,793.97 =   1,375,654.97

Journal Entry to record (a) and (b) the same would be

Asset A/c (Oil Rig Account) Debit 1,375,654.97

To Bank Account Credit 1,251,861

To Provision for Decommissioning Account Credit 123,793.97

--------------------------------------------------------------------------------------------------------------------------------------------------------------

2) Record the adjusting Journal entry pertaining to the Asset Retirement Obligation at the end of 2020 fiscal year end. -

Answer - At the end of each year the company would have to do unwinding of discount on the provision for decommissioning cost. Please remember that the fiscal year of the company is ending on 30th November, 2020 and the oil rig was purchased on 01 July 2020 hence, only 5 months entry could be recorded for this year.

The total Interest for 3 years would be as follows:-

3 years	143307	5%
Year	Opening	Int @ 5%	Closing
1.00	123,793.97	6,189.70	129,983.67
2.00	129,983.67	6,499.18	136,482.85
3.00	136,482.85	6,824.14	143,306.99
	TOTAL Interest	19513.02

However, in the first year we can only charge for 5 months hence, the amount would be =6189.70*5/12 = 2,579.04

Year opening Int @ 5% for 5 months from 01 july till 30 nov Closing

0 123,793.97 2,579.04 126,373.011

The Journal enry for the same would be :-

Interest Expense Account Debit 2,579.04

To Decommissioning Liability Account Credit 2,579.04

(Being unwinding of discount charged for 5 months this year.)

------------------------------------------------------------------------------------------------------------------------------------------------------------

3) Record the adjusting entry for depreciation interest since the company follows the Straight Line method -

Answer -

Since the asset is to be depreciated based on straight line method and has a useful life of 3 years the depreciation charge should be 1,375,654.97/3 = 458,551.65 for each of the 3 years.

However, again we can only charge for 5 months this year since the oil rig was bought in the middle of the year.

Since the fiscal year of company is 30th november so we can only charge for 5 months this year -

= 458,551.65 *5/12 = 191,063.19 to be charged for this year.

--------------------------------------------------------------------------------------------------------------------------------------------------------

4) Record the Journal Entry for the Asset Retirement Obligation at the end of the rig's useful life -

Answer -

Please notice that At the beginning of purchasing of Oil rig the company had estimated the cost of decommissioning 143,307 and had made the provision accordingly of the same amount, however, the actual cost was 150,472 (which is 7165 higher than the earlier estimation.)

At the end of its useful life the decommissioning cost would have to be paid and since the company does not have any residual value.

The decommissioning liability amount has increased thereby increasing our liability :-

Decommissiong liability Account Debit 143,307

Increase in decommissioning cost Debit 7,165

To Bank Account Credit 150,472

(Being decommissioning liability paid, at some places you may find it written as Asset obligation Account in place of decommissioning liability Account)

-------------------------------------------------------------------------------------------------------------------------------------------------------------

If this answers helps you, please give a thumbs up... would mean a lot.

Thank you.

Wish you all the luck with numbers :)