Accounting for Oil Platform and Downward Adjustments to Expected Cost

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April 17, 2012

Grimwald Glenshaw, CFO
Pumpjack Petrol, Ltd.
18111 Nordhoff Street
Northridge, CA 91340

Dear Mr. Glenshaw:

Upon your request, I have researched the codifications on how to account for the future dismantling cost of the oil platform and for downward adjustments to the expected cost. The asset retirement obligation (ARO) of $2,158,925 for the platform must be recognized on its acquisition date in 2014 and discounted to its fair value of $999,999. However, if there is a downward adjustment of $500,000, the change in estimate will be adjusted prospectively in the year the change occurred being 2022.

The future liability of $2,158,925 must be discounted to reflect its fair value at its acquisition date. According to FASB, 2012, ASC ¶ 410-20-30-1, “An expected present value technique will usually be the only appropriate technique with which to estimate the fair value of a liability for an asset retirement obligation.” Since asset retirement obligation must be recognized at the acquisition of the oil platform, the future liability for year 2023 must be discounted to reflect the liability fair value on the acquisition date (FASB, 2012, ASC ¶ 410-20-25-4).

Having determined the fair value of the liability, the oil platform will be capitalized and incur liability of $999,999 at acquisition. According to FASB, 2012, ASC, ¶ 410-20-25-5, “Upon initial recognition of a liability for an asset retirement obligation, an entity shall capitalize an asset retirement cost by increasing the carrying amount of the related long-lived asset by the same amount as the liability.” The liability will then be expensed using the 8% cost of capital as the platform is operated for each year until the liability is settled.

The downward adjustment of $500,000 will be corrected in 2022 and will The 500,000 must be discounted at the appropriate factor for 2 years and interest of 8%. We then discount 428,760 from the original estimation just for that year in...
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