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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Pete’s Petroleum, Inc., an SEC registrant with a calendar year-end, is in the business of constructing and operating offs] lore oil platforms. Pete’s Petroleum is required legally to dismantle and remove the platforms at the end of their useful lives, which is estimated to be 10 years. On January 1, 2019, Pete constructed and began operating an offshore oil platform off the coast of Brazil. The total capitalized cost to construct the platform was $3,700,000. In addition, while the future cost of dismantling the oil platform is difficult to estimate, Pete believes there is a 40% chance that the future cost will be $1,425,000, a 40% chance it will be $1,650,000, and a 20% chance that it will cost $2,125,000. The appropriate discount rate is 12%, and Pete uses the straight-line method of depreciation.

Required:

  1. 1. Prepare the journal entries that Pete should record in 2019 related to the oil platform.
  2. 2. Prepare an amortization schedule for the asset retirement obligation.
  3. 3. Next Level Prepare a table showing the effect of accounting for the asset retirement obligation on assets, liabilities, shareholders’ equity, and net income relative to accounting for the associated costs at the end of the asset’s service life when the expenditure is made.

1.

To determine

Prepare journal entries for the given transactions.

Explanation

Depreciation expense: Depreciation expense is a non-cash expense, which is recorded on the income statement reflecting the consumption of economic benefits of long-term asset on account of its wear and tear or obsolesces.

Straight-line depreciation method: The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset is referred to as straight-line method.

Prepare journal entries for the given transactions as follows:

:

DateAccount Title & ExplanationDebit ($)Credit($)
January 1, 2019Oil Platform (2)4,232,865
 Cash  3,700,000
     Asset Retirement Obligation (1) 532,865
 (To record the acquisition of oil platform)

Table (1)

  • Oil Platform is an asset and it is increased by $4,232,865. Therefore, debit the oil Platform account with $4,232,865.
  • Cash is an asset, and it decreases the value of assets by $3,700,000. Therefore, credit trucks account with $3,700,000.
  • Asset retirement obligation is an asset, and it decreases the value of assets by $532,865. Therefore, credit asset retirement obligation account with $532,865.

Working note (1):

Cost (a)% increase (b)Total (a×b)
1,425,00040%570,000
1,650,00040%660,000
2,125,00020%425,000
Total cost (A) 1,655,000
Present value of TVM Module (B) 0.321973
(A×B) 532,865

Table (2)

Note:

The Present value of $1 for 10 years at 12% is 0.321973 (refer table 3 in TVM module)

2.

To determine

Prepare an amortization schedule of Company P for the asset retirement obligation.

3.

To determine

Prepare a table showing the effects of financial statements.

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