Question

Zebra Ltd erected an oil rig in Camel River. The cost of the rig and associated technology amounted to $ 8,000,000 during the reporting period ending 30 June 2019.

The oil rig commenced production on 1 July 2019. At the end of the rig’s useful life, which is expected to be 3 years, Nichol Ltd agreed to dismantle the oil rig, remove it, and return the site to its original condition due to moral obligation. After consulting its own engineers and environmentalists, Zebra Ltd estimates that if such work was required to be done at the present time it would cost $1,000,000.

The cost of this are expected to increase by an average of three percent per year over the next three years.

The rate on 4-year government bonds reflects the relevant time value of money, and the rate is 4 percent.

The accountant of the company has ALREADY calculated the following for you:

1)      Adjusted future cost: $1 092 727    

2)      The present value of the restoration costs: $934 068

Required:

Prepare the journal entries necessary to account for the establishment of the rig and the changing balance of the restoration provision for the years ended 30 June 2019.  

Answer 1

Journal Entries

To account the establishment of Rig

Oil rig (Fixed Asset) Dr 8,000,000

Cash/Accounts payable    Cr 8,000,000

To account for decommissioning provision

Oil rig (Fixed Asset) Dr 934,068

Provision for decommissioning Cr 934,068

Decommissioning cost should be capitalized the date the obligation to do them arise, in this case there is an agreement to decommission the oil rig at the end of 3rd year, this is an obligation to the company and are to be accounted appropriately.

This provision for decommissioning is adjusted with the interest rate (interest rate that is used to arrive at the present value) over the three year period to arrive at the actual outflow for decommissioning at the end of the third year.

Note - The calculation of accountant is assumed to be correct.This answer is prepared with regard to guidance of IFRS.