Question

Flounder's Steelers Inc. (MSI) is a steel manufacturing company located in Ontario. On November 1, 2018, MSI acquired land on which it constructed a facility for steel manufacturing purposes. Since its manufacturing process produces excessive waste, the government of Ontario has imposed a requirement for MSI to clean up property. As part of its agreement with the province of Ontario, MSI is allowed to operate on this site for only 15 years after which time MSI estimates it will need to incur $2,200,000 to clean up the site. The company's discount rate is 5% and MSI reports under IFRS with a December 31 year-end. What adjusting journal entry should MSI make to initially recognize the ARO under IFRS? (Round answer to O decimal places, e.g. 5,275. Credit account titles are automatically indented when the amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter O for the amounts.) Debit Credit Date Account Titles and Explanation November 1, 2018 eTextbook and Media

Answer 1

Date	Account titles and explanation	Debit	Credit
1-Nov-18	Property Plant & Equipment (Steel manufacturing facility)	$1,058,238
	Asset Retirement Obligation		$1,058,238
	(Being asset retirement obligation recognised)
31-Dec-18	Finance Cost	$8,819
	Asset retirement obligation		$8,819
	(Being recording the interest expense for the expired period)
31-Dec-18	Deprreciation expense	$11,758
	Accumulated depreciation - Steel manufacturing facility		$11,758
	(Being depreciation of decommissioning cost recorded)

Working notes :

Asset retirement obligation at the end of 15 years = $2,200,000

n = 15 years

discount rate i = 5%

Present value of this asset retirement obligation = $2,200,000 / (1+5%)^15  

= $1,058,238

So, first set on Nov. 1 , 2018 is to record the asset retirement obligation at its present value,i.e,$1,058,238. As and when each year expires, the finance expense in terms of discount (difference between ARO future value and present value) will be debited for each period and ARO account credited, such that at the end of 15 years the account will have balance equal to $2,200,000, which is the required ARO amount after 15 years. Further, the present value calculated needs to be depreciated over the useful life,i.e, 15 years. Since no method of depreciation is given in the question, we assume straight line depreciation.

So, at year end, two entries will be recorded. One to recognise finance costs and second to record depreciation (as in table above).

Finance cost at year end is calculated as $1,058,248 * 5% * 2 / 12 = $8,819

5% being the discount rate, so at each year end, we need to recognise the finance cost using discount rate used so as to bring the present value to the future value at the end of total 15 years. Further, it is multiplied * 2 and divided by 12 because, in 2018 we will recognise same for 2 months only since only two months have expired. Next year onwards, finance cost will be recognised for full year.

The present value of decommissioning cost $1,058,238 also needs to be depreciated over time. Using straight-line depreciation method, the annual depreciation will be $1,058,238 / 15 = $70,549. Further, like finance expense, depreciation will also be recognised for the two months expired in the current year. So, depreciation for the year will be $70,549 * 2/ 12 = $11,758.