Question

Champion Incorporated is a Canadian company that manufactures steel. On January 2, 2020, Champion purchased a building for $25,000,000 that it will use for manufacturing its products. The building has a useful life of 20 years with no estimated residual value. To comply with regulatory code, the government requires Champion to clean up the property on which the building is located at the end of the building’s useful life. Champion estimates that the clean up will cost $2,200,000. Assume that the clean up costs relate entirely to the purchase of the building, not to operations over the next 20 years.

The company’s discount rate is 5%. Champion adheres to IFRS and has a December 31 year end. Champion uses the straight-line method to depreciate all its buildings.

Required:

Prepare journal entries to record each of the following:

1. The cost of the building on January 2, 2020.
2. The asset retirement obligation on January 2, 2020.
3. Any year end adjustments required for the building and the asset retirement obligation on December 31, 2020.

Answer 1

Asset Retirement Obligation is a liability related with the building. The expected cost of cleaning up the property is $22,00,000.

 

Therefore the net present value of cleaning cost = $22,00,000/(1+5%)^20 

                                                                                       = 8,29,157

 

Building ac Dr                                                            25,829,157

To Bank ac Cr                                                             25,000,000

To Asset Retirement Obligation ac Cr                        8,29,157

 

Adjustment Entries at year end:

The useful life of the building is 20 years. Straight Line Method is followed here.

Depreciation Expense ac Dr                                          12,91,458

To Accumulated Depreciation ac Cr                             12,91,458

 

Note* Depreciation = 25,829,157 /20 

                                    = 12,91,458

 

Since the useful life is decreasing year by year, it is advised to make journal entry of Asset Retirement Obligation to expenses.

Expense ac Dr                                                   41,458

To Assest Retirement Obligation ac Cr          41,458

Note * Expense = 8,29,158*5% 

                              = 41,458