Question

On January 1, 2016, Barbosa Company purchased a coal mining site for $1,000,000. Under the terms of the purchase agreement, Barbosa must restore the site to specified conditions at an estimated cost of $125,000. Barbosa estimates that it will be able to operate the site for 20 years. Barbosa uses a 6% discount rate and a straight-line method of depreciation. Required: 1. Prepare the journal entry necessary to record the purchase of the coal mining site. 2. Prepare any journal entries needed at December 31 with regard to this mining site. 3. Next Level What is the conceptual justification that underlies the accounting for an asset retirement obligation?

Answer 1

Answer:

On January 1, 2016 Barbosa Company purchased Coal mining site for $1,000,000

Estimated cost of restoration $125,000

Estimated operations in state 20 years

Discount rate 6%T

otal cost of mine = Purchase cost + Cost of restoration

= $1,000,000 + $125,000

= $1,125,000

               

Journal Entry on January 1, 2016:

Purchase Coal Mine A/c Dr $1,125,00 Cash Cr            $1,125,000

Working Note:

Since the Barbosa must restore the site to specified conditions at an estimated cost of $125,000, hence it should create the Asset Retirement Obligation in its balance.

Restore cost = $125,000

Discount rate = 6%

Present value of restore costs = $125,000 / (1+0.06)^{20 =} $125,000 * 0.3118 = $38,975

Journal entry:

Coal Mines A/c                  Dr           $38,975

Asset Retirement Obligation       Cr            $38,975

               

Interest Expenses           Dr           $2,338($38,975 * 6%) Asset Retirement Obligation       Cr            $2,338