Question

Now assume that you have been asked how to account for the destroyed drilling operation in the Gulf of Mexico in terms of the destroyed rig and lost natural resources. For this scenario, assume that BP owned this rig and it had an original cost of $225 million, which had been depreciated down to a current book value of $160 million. Also assume that oil rights had been purchased for $4 billion and had been 35% depleted. Provide a rationale, based on accounting standards, for how this operation should be retired.

Answer 1

As per IAS 16 - Property, Plant and Equipment,

The carrying amount of an item of property, plant and equipment should be de-recognized on disposal, by sale, by entering into a finance lease or by donation or when no future economic benefits are expected from its use or disposal.

The gain or loss arising from de-recognition of an item of property, plant and equipment should be included in the statement of Profit and Loss.

IAS 38 - Intangible Assets also states that an intangible asset should be de-recognized if no future economic benefits are expected from its use.

In the given case, the Oil Rig has been destroyed of all its natural resources. The Oil Rights are useful when the Oil Rig has the natural resources required which provides value. Both the Oil Rig and Oil Rights do not possess any value and no economic benefits can be expected from its use or disposal.

Hence, the Oil Rig and Oil Rights need to be written off.

Current Book Value of Oil Rig = $ 160 million

Carrying Amount of Oil Rights = $ 4 billion - 35% = $ 2.6 billion

Journal Entry for writing off the Oil Rig -

Loss on disposal ( P & L A/c)	160 million
Accumulated Depreciation A/c	65 million
To Oil Rig A/c		225 million

Journal Entry for writing off the Oil Rights -

Loss on disposal ( P & L A/c)	2600 million
Accumulated Amortization A/c	1400 million
To Oil Rights A/c		4000 million