Question

On March 1, 2018, Shipley Resources entered into an agreement with the state of Alaska to obtain the rights to operate a mineral mine for $6 million. The mine is expected to produce 100,000 tons of mineral. As part of the agreement, Shipley agrees to restore the land to its original condition after mining operations are completed in approximately five years. Management has provided the following possible outflows for the restoration costs that will occur five years from now:
Cash Outflow Probability$300,000 25%400,000 50%500,000 25%
Shipley's credit-adjusted risk-free interest rate is 10%. During 2018, Shipley extracted 18,000 tons of ore from the mine. How much accretion expense will the company record in its income statement for the 2018 fiscal year?
a. $30,326.b. $20,697.c. $24,837.d. $27,294.

Answer 1

Answer:

b. $20,697

Explanation:

In order to calculate the accretion expense, we must first evaluate the present value as shown below:

Present value would be

= Annual cash flows × PVIF factor for five years at 10%

where,  

Annual cash flows would be

= Probability 1 × cash outflows 1 + Probability 2  × cash outflows 2 + Probability 3 × cash outflows  3

= 25% × $300,000 + 50% × $400,000 + 25% × $500,000

= $75,000 + $200,000 + $125,000

= $400,000

And, the PVIF would be 0.62092. Refer to the PVIF table

So, the present value would be

= $400,000 × 0.62092

= $248,368

Now the accretion expense would be

= $248,368 × 10% × 10 months ÷ 12 months

= $20,697

The 10 months are measured between 1 March and 31 December and we presume that the books will be closed on 31 December