[jessanqi]

Hi, I think the expense in Yr 10’s financial statements should also include the depreciation of the $150,000 on that year right?

(150,000/10)=15000 depreciation expense
5,000 unexpected loss

Total should be $20,000 expense.

Anyone can kindly advise?? 🙂

On January 1 ten years ago, Andrew Co. created a subsidary for the purpose of buying an oil tanker depot at a cost of $1,500,000. Andrew expected to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove underground storage tanks. It was estimated that it would cost $150,000 to dismantle the depot and remove the tanks at the end of the depot’s useful life. However, the actual cost to demolish and dismantle the depot and remove the tanks in the tenth year is $155,000.

What amount of expense should Andrew recognize in its financial statements in year 10?

A. None, recognized in prior years.
B. $5,000 expense
C. $150,000 expense.
D. $155,000 expense

Explanation

The correct answer is B. Firms must recognize an asset retirement obligation (ARO) liability at the time of acquisition. The ARO liability equals the present value of the expected cost of dismantling the oil tanker depot of $150,000. To offset the credit portion of the ARO, the ARO amount must be capitalized as an increase in the carrying amount of the oil tanker depot.

The actual cost to demolish and dismantle the depot and remove the tanks in the tenth year is $155,000, which is $5,000 more than the estimated initial cost. The $5,000 additional dismantling cost would be recognized as an expense in the tenth year.

Journal entries to record these transactions:

1. At time of acquisition:

Debit: Oil Tanker Depot $1,650,000
Credit: ARO – Oil Tanker Depot
$150,000
Credit: Cash
$1,500,000
2. In year 10 at time of dismantling oil tanker:

Debit: ARO – Oil Tanker Depot $150,000
Debit: Dismantling Expense $5,000
Credit: Cash
$155,000

Answer A is incorrect because the dismantling and removal costs exceed the ARO liability. The additional expense must be recorded in year 10.

Answer C is incorrect because the $150,000 represents the estimated cost of dismantling and removal. The actual cost to demolish and dismantle the depot and remove the tanks in the tenth year is $155,000, which is $5,000 more than the estimated initial cost. The $5,000 additional dismantling cost would be recognized as an expense in the tenth year.

Answer D is incorrect because the $155,000 represents the total amount paid for dismantling and removal. The $5,000 ($155,000 – $150,000) additional dismantling cost would be recognized as an expense in the 10th year as the initial $150,000 was expensed over the 10 years through both depreciation and accretion expense.