Question

Asset Retirement Obligation

On January 1, 2013, Major Company purchased a uranium mine for $800,000. On that date, Major estimated that the mine contained 1,000 tons of ore. At the end of the productive years of the mine, Major Company will be required to spend $4,200,000 to clean up the mine site. The appropriate discount rate is 8%, and it is estimated that it will take approximately 14 years to mine all of the ore. Major uses the productive-output method of depreciation. During 2013, Major extracted 100 tons of ore from the mine.

Click here to access the FV table to use with this problem. Round the cost of the uranium mine to the nearest dollar. In your calculations, round the depletion per ton to the nearest dollar.

Compute the amount of depreciation (or depletion) expense for 2013.

$   

Compute the amount of accretion expense for 2013.

$   

Answer 1

Solution

Major Company

Computation of the amount of depreciation (or depletion) expense for 2013:

Depletion expense = depletion base x tons of mine extracted in current year/total mine available for extraction

Depletion base = cost + development costs – salvage value

Depletion base = ?

Mine extracted in 2013 = 100 tons

Available mine = 1,000 tons

depletion base = total present value

present value,

cost to clean up the mine site = $4,200,000

present value discounted at 8% for 14 years = $4,200,000/(1+8%)¹⁴

            = $1,429,936

Add: purchase value of the ore = $800,000

Cost of the mine = $2,229,936

Depletion per ton = $2,229,936/1,000 = $2,230 per ton

Depletion expense for 2013 = $2,230 x100 = $223,000

Note: Depletion expense is calculated on the present value of the decommission or cost to clean up the mine plus cost of purchase of the mine.

2. Accretion expense for 2013:

Asset retirement obligation = $1,429,936

Finance cost = $1,429,936 x 8% = $114,395

Hence, the accretion expense for 2013 = $114,395

Asset retirement obligation as at December 31, 2013 = $1,429,936 + $114,395 = $1,544,331

The ARO will increase over the period of 14 years to reach $4,200,000 at the time of actual clean up of the mine.