Question

(Asset Retirement Obligation) Oil Products Company purchases an oil tanker depot on January 1, 2017, at a cost of \(600,000. Oil Products expects to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove the underground storage tanks. It is estimated that it will cost \)75,000 to dismantle the depot and remove the tanks at the end of the depot’s useful life.

Instructions

1. Prepare the journal entries to record the depot and the asset retirement obligation for the depot on January 1, 2017. Based on an effective-interest rate of 6%, the present value of the asset retirement obligation on January 1, 2017, is \(41,879.
2. Prepare any journal entries required for the depot and the asset retirement obligation at December 31, 2017. Oil Products uses straight-line depreciation; the estimated salvage value for the depot is zero.
3. On December 31, 2026, Oil Products pays a demolition firm to dismantle the depot and remove the tanks at a price of \)80,000. Prepare the journal entry for the settlement of the asset retirement obligation.

Short answer

1. Both sides of the journal totals$641,879.
2. Both sides of the journal totals$66,701.
3. Loss on settlement is$5,000.

Step-by-step solution

Definition of Asset Retirement Obligation

The obligations that a business entity is required to fulfill against the retirement of the intangible and plant assets held in the business are known as asset retirement obligations.

Journal entries to record the depot and asset retirement obligation for the depot on January 1, 2017

Date	Accounts and Explanation	Debit $	Credit $
1	Plant assets	$600,000
	Cash		$600,000
2	Plant asset	$41,879
	Asset retirement obligation		$41,879
		$641,879	$641,879

Journal entries to record the depot and asset retirement obligation at 31 December 2017

Date	Accounts and Explanation	Debit $	Credit $
1	Depreciation expenses$\left(\frac{\$600,000}{10}\right)$	$60,000
	Accumulated depreciation		$60,000
2	Depreciation expenses$\left(\frac{\$41,879}{10}\right)$	$4,188	$4,188
	Accumulated depreciation
3	Interest expenses$\left(\$41,879\times 6\%\right)$	$2,513
	Asset retirement obligation		$2,513
		$66,701	$66,701

Journal entry for settlement of the asset retirement obligation

Date	Accounts and Explanation	Debit $	Credit $
1	Asset retirement obligation	$75,000
	Loss on ARO settlement	$5,000
	Cash		$80,000