Question

Kent Mining Company [CMC] prospects for new minerals on Krypton and other nearby planets. It sets up operations on a neighboring planet Zippon after discovering vast deposits of a very rare mineral which is used in producing solid state fuel for space transportation. The Zippon government has been very strict on ecological preservation on its planet and has been most careful not to follow in the path of Planet Earth. CMC is required by the planetary existing laws to reclaim the site once the mining operations are completed. The company expects to close the mine after a 20-year operation, at the end of 2035 and estimates that such reclamation and restoration measures will cost $5,000,000. CMC uses a 6% annual discount rate and accrues interest semi-annually.

The cost of setting up the mine, classified as Plant and Equipment - Mining, amounted to $16,000,000. CMC attributes these costs to be the result of acquiring the mine and expects that no additional reclamation and restoration costs will be incurred in the future. It uses a fiscal year ending December 31.

The journal entry required to record the future reclamation and restoration costs when the mine began its operations would include ($ Amount; Debit/Credit - Account):

a.

$1,532,800; Credit - ARO Liability

b.

$16,000,000; Credit - ARO Liability

c.

$5,000,000; Credit - ARO Liability

d.

$17,532,800; Debit - Loss on Land Restoration

e.

$1,559,000; Credit - ARO Liability

Answer 1

The answer is a - $1,532,800.

The estimated cost of Asset Reclamation and Restoration is $5,000,000. This amount needs to be spent at the end of 20 years.

So, we need to calculate the present value of this future obligation.

We use Excel PV function as it is single cashflow.

PV(rate,nper,[pmt],[fv],[type])

where

PV = present value

rate = discount rate per period presented in decimal or percentage format.

nper = no. of periods

pmt = regular payment per period. If it is omitted, the default value is 0.

fv = Future value of the cash flow at the end of nper period. If it is omitted, the default value is 0.

type = specifies whether the payment is made at the starting or at the end of the period. If it is omitted, the default value is 0.

As interest accrues semi-annually, the rate is represented as the rate / frequency of compounding in the year. Here no. of periods is 20 ( as interst is calculated semi-annually).

=PV(6%/2,40,0,5000000,0)

=

($1,532,784.20)

Nearby answer is $1,532,800.

This amount is to be credited to ARO liability account as the company needs to account for future obligations of Asset Retirement.

Dr. Asset A/c - $1,532,800

Cr. ARO Liability $1,532,800

Answers b, c, and e are incorrect as they represent the wrong present value. D represents the wrong account debit and the wrong amount.

Present value can also be calculated by using the following formula:

PV = FV/(1+r/m)^mt

^where

^{FV = Future value}

^{r = annual interest or discount rate}

t = no. of years

m = no. of periods based on compounding frequency