World Oil and Gas Corporation completes construction of an offshore oil platform and places it into service on
January 1, 2018. World Oil and Gas Corp. is legally required to dismantle and remove the platform at the end
of its useful life which is estimated to be 10 years. On January 1, 2018, World Oil and Gas Corp. recognized a
liability for an asset retirement obligation and capitalized an amount for an asset retirement cost. It estimated
the initial fair value of the liability using an expected present value technique. The significant assumptions used
in that estimate of fair value are as follows:
a. Labor costs are based on current marketplace wages required to hire contractors to dismantle and remove
offshore oil platform. World Oil and Gas Corp. assigns probability assessment to range of cash flows estimates
ad follows:
Cash Flow Estimate Probability Assessment
$250,000 10%
175,000 60%
200,000 30%
b. World Oil and Gas Corp. estimated allocated overhead and equipment charge using the rate it applies to
labor costs for transfer pricing (60%). The entity has no reason to believe that its overhead and equipment rate
differs from that used by contractors in the industry.
c. A contractor typically adds a markup on labor, allocated internal costs, and equipment to provide a profit
margin on the job. The entity determines the profit that contractors in the industry generally earn to dismantle
and remove offshore oil platform is 15%.
d. A contractor would typically demand and receive a premium (market risk premium) for bearing the
uncertainty and unforeseeable circumstances inherent in “locking in” today’s price for a project that will not
occur for 10 years. The entity estimates the amount of that premium to be 5% of the estimated inflationadjusted cash flows.
e. The risk-free rate of interest on January 1, 2015 is 6%. The entity adjusts that rate by 4% to reflect the effect
of its credit standing. Therefore, the credit-adjusted risk-free rate used to compute expected present value is
10%. (Round the present value factor to four decimal places.)
f. World Oil and Gas Corp. assumes a rate of inflation of 4% over 10-years period. (Round the present value
factor to four decimal places.)
Required
a. Using the excel sheet and by formatting the cells, prepare the revised estimate of expected cash flows for
labor costs as shown in the table above.
b. Using the excel sheet and by formatting the cells, prepare a table showing the Initial Measurement of the
ARO Liability at January 1, 2018.
c. Using the excel sheet and by formatting the cells, prepare a table showing the Accretion: Interest Method of
Allocation.
d. Using the excel sheet and by formatting the cells, prepare a table showing the Schedule of Expenses
(Accretion of Expense and DD&A Expense).
e. Prepare the journal entries that would be made from December 31, 2018, to December 31, 2027 to record
the accretion expense and the amortization expense related to the ARO.
f. On December 31, 2027, the entity settles its asset retirement obligation by using it internal workforce at a
cost of $432,000. Assume no changes during the 10-year period in the cash flows used to estimate the
obligation. Prepare the journal entry that would be made on December 31, 2027 to record the settlement of the
g. Assume the following changes:
-The risk-free rate of interest on January 1, 2015 is 7%. The entity adjusts that rate by 4% to reflect the effect
of its credit standing. Therefore, the credit-adjusted risk-free rate used to compute expected present value is
11%. (Round the present value factor to four decimal places.)
– World Oil and Gas Corp. assumes a rate of inflation of 5% over 10-years period. (Round the present value
factor to four decimal places.)
What would be the PV of the initial measurement of the ARO, accretion expense in 2019, and DD$A expense
for ARO in 2019.
