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On 1 October 20X3 Xplorer commenced drilling for oil from an undersea oilfield. The extraction of oil causes damage to the seabed which has a restorative cost (ignore discounting) of $10,000 per million barrels of oil extracted. Xplorer extracted 250 million barrels in the year ended 30 September 20X4.
Xplorer is also required to dismantle the drilling equipment at the end of its five year licence. This has an estimated cost of $30 million on 30 September 20X8. Xplorer’s cost of capital is 8% per annum and $1 has a present value of 68 cents in five years’ time.
What is the total provision (extraction plus dismantling) which Xplorer would report in its statement of financial position as at 30 September 20X4 in respect of its oil operations?THE EXAMINER IS FIRST MULTIPLYING 30 MILLION BY 0.68 THEN APPLYING THE 8% DISCOUNT.
SIR CAN YOU PLEASE EXPLAIN WHY IS HE DOING THAT?
ThanksThe liability to dismantle the drilling equipment originated on 1 October, 2003 so that estimated cost of $30 million in 5 years’ time on 30 September, 2008 needs to be discounted to arrive at the present value as at 1 October, 2003
So as at 1 October, 2003 the discounted estimated cost of dismantling is $30,000 * .68 = $20,400,000
That’s the present value as at 1 October, 2003
But the question asks “What is the total provision (extraction plus dismantling) which Xplorer would report in its statement of financial position as at 30 September 20X4 in respect of its oil operations?”
So we now need to unroll that discounted figure of $20,400,000 by 8% to arrive at an amount of $22,032,000 ($20,400,000 * 1.08)
In addition, the site restoration costs (ignoring discounting as per the question) need to be provided for at the rate of $10,000 cost per million barrels of oil extracted
During the year ended 30 September, 2004 there were 250 million barrels of oil extracted so we need to provide 250 * $10,000 and that equates to $2,500,000
In aggregate we need to provide $24,532,000 ($22,032,000 + $2,500,000)
OK?
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