Question

On January 1, 2015 BigDig Mining company purchased a tract of land for $10 million. BigDig plans to

mine the land for diamonds and estimates that it will removed 10,000 carats of diamonds from the mine

over a period of 7 years. Federal regulations require BigDig to return the land to its original state at the

end of the mining operation. BigDig estimates it will cost $2 million to complete this restoration work,

and once complete that the land will sell for $2.5 million. BigDib typically borrows money at 8%.

a. Calculate the depletion per carat removed from the mine

b. Calculate the accretion expense to be recorded in 2015

c. What is the balance in the ARO Liability account at the end of 2016?

Answer 1

a. Cost of purchase of land = $10,000,000

PV of the cost to be incurred to return the land in its original state (Asset Retirement Obligation)

= 2,000,000 * (1/ 1.0815) = $1,166,981

Total amount to be capitalized = $10,000,000 + $1,166,981 = $11,166,981

Salvage value at the end of 7 years = $2,500,000

Total units extracted over the life = 10,000 carats

Therefore, depletion per carat removed = $11,166,981 / 10,000 carats = $1,116.70 per carat

b. Accretion Expense to be recorded in 2015 = $1,166,981 * 8% = $93,358

c. Accretion Expense to be recorded in 2016 = ($1,166,981 + $93,358) * 8% = $100,827

Therefore balance in ARO account at the end of 2016 = $1,166,981 + $93,358 + $100,827 = $1,361,166.

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