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Hello Sir,
Can you please explain the part b of promoil question
I actually did not understand the question below is the extract:On 1 October 20X7, Promoil acquired a newly constructed oil platform at a cost of $30 million together with
the right to extract oil from an offshore oilfield under a government licence. The terms of the licence are that
Promoil will have to remove the platform (which will then have no value) and restore the sea bed to an
environmentally satisfactory condition in 10 years’ time when the oil reserves have been exhausted. The
estimated cost of this in 10 years time will be $15 million. The present value of $1 receivable in 10 years at
the appropriate discount rate for Promoil of 8% is $0.46.
Thanks in anticipationWe need to calculate the present value of the commitment to restore the site so 15m x .46 = 6.9m
That 6.9 should be reflected in Promoil’s figures as an obligation (Debit Oil Platform Account, Credit Provision for Restoration Account) Of course, that now means that the asset has increased in value and that new increased value is the basis for the annual depreciation charge.
As each year goes by, Promoil needs to reassess the estimate of the restoration costs and also review its own cost of capital. Each year, it will recalculate the value of its future obligation and adjustments will be made. A revision of estimates resulting in an increase in the obligation will result in an entry being made (Debit Profit and Loss Account Credit Provision for Restoration Account) with the reverse entry being made for an adjustment resulting in a reduction in the value of the future obligation
OK?
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