• LO11–2, LO11–3, LO11–5
On May 1, 2018, Hecala Mining entered into an agreement with the state of New Mexico to obtain the rights to operate a mineral mine in New Mexico for $10 million. Additional costs and purchases included the following:
Development costs in preparing the mine | $3,200,000 |
Mining equipment | 140,000 |
Construction of various structures on site | 68,000 |
After the minerals are removed from the mine, the equipment will be sold for an estimated residual value of $10,000. The structures will be torn down.
Geologists estimate that 800,000 tons of ore can be extracted from the mine. After the ore is removed the land will revert back to the state of New Mexico.
The contract with the state requires Hecala to restore the land to its original condition after mining operations are completed in approximately four years. Management has provided the following possible outflows for the restoration costs:
Probability | |
$600,000 | 30% |
700,000 | 30% |
800,000 | 40% |
Hecala’s credit-adjusted risk-free interest rate is 8%. During 2018, Hecala extracted 120,000 tons of ore from the mine.
The company’s fiscal year ends on December 31.
Required:
1. Determine the amount at which Hecala will record the mine.
2. Calculate the depletion of the mine and the depreciation of the mining facilities and equipment for 2018, assuming that Hecala uses the units-of-production method for both depreciation and depletion. Round depletion and depreciation rates to four decimals.
3. How much accretion expense will the company record in its income statement for the 2018 fiscal year?
4. Are depletion of the mine and depreciation of the mining facilities and equipment reported as separate expenses in the income statement? Discuss the accounting treatment of these items in the income statement and balance sheet.
5. During 2019, Hecala changed its estimate of the total amount of ore originally in the mine from 800,000 to 1,000,000 tons. Briefly describe the accounting treatment the company will employ to account for the change and calculate the depletion of the mine and depreciation of the mining facilities and equipment for 2019 assuming Hecala extracted 150,000 tons of ore in 2019.
1.
Depreciation:
Depreciation refers to the reduction in the monetary value of a fixed asset due to its wear and tear or obsolescence. It is a method of distributing the cost of the fixed assets over its estimated useful life. The following is the formula to calculate the depreciation.
Depletion:
Depletion is a concept which is same as depreciation. It is the allocation of cost of natural resources to expense over resource’s the useful time in a systematic and normal manner.
Unit-of-activity Method:
Under this method of depreciation, the depreciation expense is calculated on the basis of units produced in a year. This method is suitable when a company has fluctuating productive rate. The formula to calculate the depreciation expense under this method is as follows:
To Determine: The amount at which H Mining will record the mine.
Explanation of Solution
Determine the amount at which H Mining will record the mine.
Particulars | Amount ($) |
Mining site | 1,000,000 |
Development costs | 320,000 |
Restoration costs | 521,871 |
Total | 13,721,871 |
Table (1)
Working note:
Determine the present value of the restoration costs.
Cash flows | Probability | Total | ||
$600,000 | 30% | = | 180,000 | |
$00,000 | 30% | = | 210,000 | |
$800,000 | 40% | = | 320,000 | |
Total | 710,000 |
Table (2)
Determine the present value of the total restoration cost.
Note: PV factor (Present value of $1: n = 4, i = 8%) is taken from the table value (Table 2 in Appendix from textbook).
2.
To Calculate: The depletion and depreciation on the mine and mining facilities and equipment for 2018 using units-of-production method.
Explanation of Solution
Calculate depletion expense on the mine for 2018.
Working Note:
Calculate depletion per ton.
Hence, the depletion of the mine for the year 2018 is $2,058,276.
Determine the depreciation expense for machinery for the year 2018.
Working Note:
Determine the depreciation per ton for machinery using units-of-production method.
Hence, the depreciation expense on the machinery (equipment) for the year 2018 is $19,500.
Determine the depreciation per unit for structures using units-of-production method.
Determine the depreciation expense for structure for the year 2018.
Working Note:
Hence, the depreciation expense on structures (mining facilities) for the year 2018 is $10,200.
3.
Explanation of Solution
Determine the accretion expenses recorded in the income statement for the 2018 fiscal year (May 1, 2018 to December 31, 2018).
Hence, the accretion expense for the year 2018 is $27,833.
4.
To Discuss: Whether the depletion of the mine and the depreciation of the mining facilities and equipment are reported as separate expense in the income statement, and their accounting treatment in the income statement and balance sheet.
Explanation of Solution
Yes, the depletion of the mine and the depreciation of the mining facilities and equipment are reported as separate expense in the income statement.
Accounting Treatment for Depreciation and Depletion
- The depreciation is treated as the part of the manufacturing equipment cost, and will be included in the cost of the inventory. Likewise, depletion determined is also a part of the product cost, and this cost will also be included in the inventory.
- When the mineral is sold, the depletion and depreciation cost will be included in the cost of goods sold on the income statement.
5.
To Discuss: The accounting treatment the company will employ to account for the change.
Explanation of Solution
The accounting treatment the company will employ to account for the change in estimate of the total amount of ore is that it prospectively depreciate the remaining depreciable base (book value of the asset on the date of change less any residual value) of the asset over its remaining useful life of the asset.
Calculate the depletion of the mine for the year 2019.
Working Notes:
Determine the remaining depletable cost.
Determine the revised estimate of tons remaining.
Determine the depletion rate.
Thus, the depletion for the year 2019 is $1,988,115.
Calculate the depreciation for equipment for the year 2019.
Working Notes:
Determine the remaining depreciable cost.
Determine the revised estimate of tons remaining.
Determine the depreciation rate.
Thus, the depreciation for the year 2019 is $18,840.
Calculate the depreciation of structures for the year 2019.
Determine depreciation for the year 2019.
Working Note:
Determine the remaining depreciable cost.
Determine the revised estimate of tons remaining.
Determine the depreciation rate.
Thus, the depreciation for the year 2019 is $9,855.
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Chapter 11 Solutions
GEN COMBO LOOSELEAF INTERMEDIATE ACCOUNTING; CONNECT ACCESS CARD
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