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Can you please assist me with the following questions?
1) A company set up a gas exploration site on 1 January 2001 which will operate for five years. At the end of the five years the site will need to be dismantled and the landscape restored. The amount required for dismantling and restoration, discounted at the company’s cost of capital of 8%, is $1.2 million and a provision is set up for this amount.
What is the total amount charged to profit or loss for the year ended 31 December 2002 in respect of these dismantling and restoration costs?
A. $343,680
B. $336,000
C. $103,680
D. $96,000The answer to this question is A. I was able to calculate the unwinding of the discount however, I do not understand why depreciation is charged on the discounted amount of $1.2 million instead of the full amount which will be paid at the end of the five years. What is the reasoning behind this?
2) On 1 April 2007 a company rents a warehouse under a two-year operating lease for $240,000 per annum. As an incentive to sign the contract it is given the first two months rent-free.
What amount in respect of lease rental should be charged to profit or loss for the year ended 31 December 2007?
A. $228,000
B. $168,000
C. $133,000
D. $171,000I was unable to arrive at any of the above answers for this question. The answer given at the back of the text for this question is D, however the workings given does not show the $171,000.
“however, I do not understand why depreciation is charged on the discounted amount of $1.2 million instead of the full amount which will be paid at the end of the five years. What is the reasoning behind this?”
When the provision was set up, 2 years ago, the double entry was to debit the asset and credit the provision with the PRESENT value of the restoration costs ie with $1,2m
As each year goes by we debit finance charges and credit the provision as we unwind the discount
Does that explain it?
2) I don’t understand the answer $171,000!
What I believe has happened is this:
total payable = $480,000
2 months’ free should be $40,000 free. But I believe the figure used was $24,000 (I have no idea why!)
Let’s go with $24,000 for the minute. Total payable over 24 months is $480,000 – $24,000 = $456,000 over 24 months
9 months’ worth of $456,000 / 24 = $171,000
Now that’s what I THINK has happened.
What I believe the answer should be is 2 x 240,000 = $480,000 (= $20,000 per month)
2 months free is $40,000
So payable over 24 months is $480,000 – $40,000 = $440,000
And 9 months for the year to 31 December, 2007 is 9 x $440,000 / 24 and that figure works out to be $165,000
That’s the best I can do, sorry!
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