Answer to Question #238238 in Accounting for Esty

Question

Dunlop Tyres (Pvt) Ltd (Dunlop) has an agreement to provide 100 000 truck tyres to a once-off
customer at a fixed price over two years. At the end of the first year, after providing 50 000 truck
tyres to the customer, the price of the raw materials used increased unexpectedly. Dunlop was
unable to renegotiate the sales price with its customer and would have to pay a penalty of $500
000 if it cancels the contract. It is expected that the remaining truck tyres will be delivered twelve
months after the reporting date for a total price of N$3.5 million. The total cost of producing the
truck tyres measured at the same point in time is expected to be N$4.1 million. Assume that a
discount rate of 10% per annum before tax is appropriate.
On 15 December 2020 the board of Dunlop decided to close down its Fine Tubes division. Before
the reporting date (31 December 2020), the decision was not communicated to any of those
affected and no other steps were taken to implement the decision. Concurrently, on 15 December
2020 the board of Dunlop decided to close down its Repairs and alignment division. On 22
December 2020 a detailed plan for closing down the division was agreed upon by the board;
letters were sent to customers warning them to seek an alternative source of supply, and
redundancy notices were sent to the staff of the division.
The entity Dunlop has also diversified and constructed an oil rig which is due to become
operational on 1st January Year 1. The entity had promised that when the oil rig is eventually
decommissioned it will restore the sea bed and clean up any contamination that it has caused. It
is estimated that the cost of decommissioning of the oil rig will be sold N$8m and that
decommissioning will take place in 10 years’ time. The risk free cost of capital for the company is
10% post tax. The oil rig is depreciated on a straight line basis over its economic life.
Explain how the cost of decommissioning the oil rig should be treated in the
financial statements for the year ended 31 December Year 1

Answer 1

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