Question

BPP Company maintains underground storage tanks for its operations. A new storage tank was installed and made ready for use at a cost of $400,000 on January 1, 2020. The useful life is estimated at 15 years, at which time the company is legally required to remove the tank and restore the area at an estimated cost of $40,000. The appropriate discount rate for the company is 12%.

Answer the following questions, rounding your answers to the nearest whole number. PLEASE SHOW YOUR CALCULATIONS

a. Record the storage tank asset and the related asset retirement obligation on January 1, 2020.

b. Record any required adjusting entries on December 31 2020.

c. Assume that on December 31, 2035, the tank is safely removed at a cost of $46,000. Record the required journal entry.

Answer 1

Part A

On 1st Jan 2020

	DR	CR
Storage Tank Asset A/C	40000
To Cash/Bank		40000
( Being purchase is accounted )
Storage Tank Asset A/C	7308
To Asset Retirement Obligation		7308
( Being present value of asset retirement obligation is accounted- See Working Note )

Working Note

Asset Retirement Obligation= Estimated Cost * PVF (12%, 15 years )

= 40000* 0.1827

= 7308.

Part B

On 31 Dec 2020

An Interest will be calculated on the above amount @12% each year, so that at end of 15 th year the amount of Asset Retirement Obligation account will be equal to 40000.

	DR	CR
Depreciation A/C	26667
To Accumulated Depreciation		26667
( Being depreciation accounted ie, 400000/15 )
Interest A/C	877
To Asset Retirement Obligation		877
( Being Interest on asset retirement obligation is accounted- 7308*12% )

Part C

On 31 Dec 2035

	DR	CR
Asset Retirement Obligation A/C	40000
Loss on Asset Retirement A/C	6000
To Cash/Bank		46000
( Being Storage Tank removal accounted )

Initially amount expected asset retirement cost after 15 years is 40000 but after 15 years the amount incurred is 46000, thereby loss of 6000 is accounted.