Question
The question here is to determine the associated COSTS to the Asset Retirement Obligation in Jan 1, 2018. and construction of the plant in 2017.
The question here is to determine the associated COSTS to the Asset Retirement Obligation in Jan 1, 2018. and construction of the
plant in 2017. I am not sure how to approach this kind of long answer question because there are a lot of elements to choose from and a lot of words are used to confuse me.
Will the deprecation for that year be calculated on the ARO?
You have started on a new job with the designation of VP-Special Assignments and Issues. Before you
could even get comfortable in your supersoft executive leather chair, in strides your boss, Ackque Feegerz
carrying a sheaf of papers. "Ah, nothing looks better than a busy accountant on a Monday morning," then
looked at his watch and added, "you are already 15 minutes behind schedule. We do not pay for idle time
and so from tomorrow, do come in at least an hour before office starts." Then he deposited two files on
your desk, and remarked, "Do please sort these out before 11:00 AM and begin with File I. Don't bother
me with petty questions. You are expected to take independent decisions, my man," and he was gone.
His note pinned on the folder informed you that it was essential for you to show sufficient details in your
responses. And thus you start your day with this File I!
The company, Digi Communications, Inc., [DCI], began as a small startup firm in the late twentieth
century but in five years, it grew rapidly and expanded competitively into several areas of this industry. It
is currently operating internationally and its shares are listed on the NYSE. Its reporting platform is IFRS
and has a fiscal year-end of December 31.
You now begin work on the file related to the obligations for asset retirement. In late 2016, it procured a
permit to strip mine 1,000 acres of pristine land in the western regions of Saskatchewan. The provincial
government had issued the lease free of cost as a grant to stimulate employment in this region. The
company had earlier submitted a legally binding comprehensive plan which included a timetable for the
full reclamation of the land at the end of this lease. Although the permit is valid for ten years from the
date of the commencement of operations, the management is expecting to finish its mining after
seven years. Once it has closed the mine, DCI will restore the land and ground cover to its original
topographical condition then provide reforestation, and finally encourage rehabilitation of pre-existing
wildlife to the area. DCI will also engage in activities designed to minimize the air and water pollution
created by the strip mining process.
DCI has made the following estimates regarding the ultimate cost of the asset retirement obligation if the
work was done currently:
L 1. All relevant labor cost estimates related to this reclamation work are currently $20 per hour.
However, DCI is certain that this cost will increase by 10% by the end of the next seven years
and then level off.
L 2. It will take approximately 10 hours per acre related to the restoration work on the soil, ground
cover and tree planting. Similarly, the cost of equipment used for this work plus additional
overhead costs is expected to be 75% of these labor costs.
L 3. Other grass seeding and tree planting costs (seeds and trees) estimate is $1,100 per acre.
L 4. The company has not previously made any attempts to restore pre-existing wildlife (several bird
species, garter snakes) on its other property investments. Based on conservative estimates, these
costs have been pegged at $500,000 for this project.
L 5. The company was legally obligated to finish of the restoration work within six months of
ending the mining operation.
L 6. The estimates of the restoration work (points 2 through 4 above) were made based on current
prices. However to accommodate possible future price increases to when the work will be
performed, the company expects to pay an additional 15% of the restoration estimate described in
points 2 through 4.
L 7. The initial investment to set up the plant and equipment in order to commence the mining work
was estimated to be $21,000,000 and was classified as Asset - Landmine. The plant was
scheduled to be set up and paid for in 2017 and the production was scheduled to commence on
January 1, 2018. A discount rate of 4% per annum was considered to be realistic. Finally, the
company will account for the ARO from the date of the commencement of the production
process.
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