Oil Company Limited (OCL) is in the oil and gas business and operates internationally. The company is public and lists on the National Stock Exchange. In the past two years, oil prices have been declining significantly. The company’s Canadian operations are primarily located in Western Canada and consist of holdings in what are known as the “tar sands.” Costs to extract the oil from these types of geological formations are fairly high. In some months in the past year, the cost to extract the oil has been higher than the market price.
OCL is worried that oil prices will continue to decline and has therefore decided to write down its productive asset. To this end, the company needs to calculate the value in use and fair value less costs to sell. The higher value will be used to measure the impairment loss and to revalue the property. Financial analysts who follow the company (and other companies in the oil and gas sector) understand that the lower oil and gas prices are negatively affecting share prices. The land otherwise has little market value.
Instructions
Adopt the role of OCL’s controller and discuss how to measure the value in use and fair value for purposes of recording an impairment loss and the writedown of the Canadian operations.
