• 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.
Want to see more full solutions like this?
Chapter 11 Solutions
SPICE ND LL INTERM ACCTG W/CONN+ AC
- P11.1 (LO 2 ) (Depreciation for Partial Period—SL, SYD, and DDB) Alladin Company purchased Machine #201 on May 1, 2020. The following information relating to Machine #201 was gathered at the end of May. Price $85,000 Credit terms 2/10, n/30 Freight-in $ 800 Preparation and installation costs $ 3,800 Labor costs during regular production operations $10,500 It is expected that the machine could be used for 10 years, after which the salvage value would be zero. Alladin intends to use the machine for only 8 years, however, after which it expects to be able to sell it for $1,500. The invoice for Machine #201 was paid May 5, 2020. Alladin uses the calendar year as the basis for the preparation of financial statements. Instructions a. Compute the depreciation expense for the years indicated using the following methods. (Round to the nearest dollar.) 1.Straight-line method for 2020. 2.Sum-of-the-years'-digits method for 2021.…arrow_forwardP10.5 (LO 2, 3, 5), AP At December 31, 2022, Grand Company reported the following as plant assets. Land $4,000,000Buildings $28,500,000 Less: Accumulated depreciation—buildings 12,100,000 16,400,000Equipment 48,000,000 Less: Accumulated depreciation—equipment 5,000,000 43,000,000Total plant assets $63,400,000During 2023, the following selected cash transactions occurred. April 1 Purchased land for $2,130,000.May 1 Sold equipment that cost $750,000 when purchased on January 1, 2019. The equipment was sold for $450,000.June 1 Sold land purchased on June 1, 2013 for $1,500,000. The land cost $400,000.July 1 Purchased equipment for $2,500,000.Dec. 31 Retired equipment that cost $500,000 when purchased on December 31, 2013.arrow_forwardProblem 10-9 (Algo) Interest capitalization; specific interest method [LO10-7]On January 1, 2021, the Mason Manufacturing Company began construction of a building to be used as its office headquarters. The building was completed on September 30, 2022. Expenditures on the project were as follows:January 1, 2021$1,280,000March 1, 2021720,000June 30, 2021920,000October 1, 2021720,000January 31, 2022288,000April 30, 2022621,000August 31, 2022918,000 On January 1, 2021, the company obtained a $3,200,000 construction loan with a 15% interest rate. The loan was outstanding all of 2021 and 2022. The company’s other interest-bearing debt included two long-term notes of $3,000,000 and $7,000,000 with interest rates of 11% and 13%, respectively. Both notes were outstanding during all of 2021 and 2022. Interest is paid annually on all debt. The company’s fiscal year-end is December 31. Required:1. Calculate the amount of interest that Mason should capitalize in 2021 and 2022 using the specific…arrow_forward
- Problem 8No Control Mining purchased land on February 1, 2019, at a cost of P1,250,000. It estimated that a total of 60,000 tons of mineral was available for mining. After it has removed all the mineral resources, the company will be required to restore the property to its previous state because of strict environmental protection laws. It estimates the fair value of this restoration obligation at P90,000. It believes it will be able to sell the property afterwards for P100,000. It incurred developmental costs of P200,000 before it was able to do any mining. In 2019, resources removed totaled 30,000 tons. The company sold 24,000 tons.RequiredCompute the following information for 2019.a. Per unit mineral cost.b. Total material cost of December 31, 2019, inventory.c. Total materials cost in cost of goods sold at December 31, 2019.arrow_forwardP11.2 (LO 1, 2) (Deprec. for partial periods - SL, Act., SYD, and Declining - Balance) The cost of equip. purchased by Charleston, Inc. on June 1, 2020, is $89,000. It is estimated that the machine will have a $5,000 salvage value at the end of it's service life. It's service life is estimated at 7 years, it's total working hours are estimated at 42,000, and it's total production is estimated at 525,000 units. During 2020, the machine was operated 6,000 hours and produced 55,000 units. During 2021, the machine was operated 5,500 hours and produced 48,000 units. Instructions: Compute deprec. expense on the machine for the year ending Dec. 31, 2020, and the year ending Dec. 31, 2021, using the following methods. a. Straight-line. b. Units-of-output. c. Working hours. d. Sum-of-the-years'-digits. e. Declining-balance (twice the straight-line rate).arrow_forwardExercise 9.3 (Algo) Depreciation for Partial Years (LO9-3) On August 3, Cinco Construction purchased special-purpose equipment at a cost of $7,600,000. The useful life of the equipment was estimated to be eight years, with an estimated residual value of $20,000. a. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the straight-line depreciation method (half-year convention). b. Compute the depreciation expense to be recognized each calendar year for financial reporting purposes under the 200 percent declining-balance method (half-year convention) with a switch to straight-line when it will maximize depreciation expense. c. Which of these two depreciation methods (straight-line or double-declinin.arrow_forward
- P11.11 (LO4) (Mineral Resources) Phelps Oil Wildcatters plc has leased property on whichoil has been discovered. Wells on this property produced 36,000 barrels of oil during thepast year, which sold at an average sales price of £65 per barrel. Total oil resources of thisproperty are estimated to be 500,000 barrels. The lease provided for an outright payment of£1,200,000 to the lessor (owner) before drilling could be commenced and an annual rental of £62,000. A premium of 4% of the sales price of every barrel of oil removed is to be paidannually to the lessor. In addition, Phelps (lessee) is to clean up all the waste and debrisfrom drilling and to bear the costs of reconditioning the land for farming when the wells areabandoned. The estimated fair value, at the time of the lease, of this clean-up andreconditioning is £50,000.Instructionsa. From the provisions of the lease agreement, compute the cost per barrel for the pastyear, exclusive of operating costs, to Phelps.b. Compute the…arrow_forwarda H 12 15 18 An oil company paid a landowner $30,000 for the mineral rights underlying his property. The well was drilled and equipped at a cost of $900,000. It is estimated that 300,000 barrels of oil will be produced from the property. How should this cost be treated in the accounting records? The cost of the mineral rights should be capitalized and depleted over the estimated units of production. The drilling equipment should be capitalized and depreciated over its estimated useful life Both of the answers are correct. None of the answers are correct.arrow_forward7.3 q1- A 7-year project requires equipment costing $13,000. Tax law requires the use of straight-line depreciation on this type of equipment, and sets the maximum depreciation rate at 10% p.a. What is the book value of the equipment at the end of the project? a. $4100 b. $0 c. $4300 d. $3900arrow_forward
- Title 12.1 Metal Stampings, Inc., can purchase a new forging machine for $400,000. After 20 years of use,... Description 12.1 Metal Stampings, Inc., can purchase a new forging machine for $400,000. After 20 years of use, the forge should have a salvage value of $25,000. (a) Under MACRS, what depreciation is claimed in year 3? Under the straight-line (pre-1981) method, what depreciation is claimed in year 3? (Answer: a. $69,960; . $18,750)arrow_forwardEx 17.6 The Gloaming company incurred the following costs during a period in relation to a specific area of interest and wants to capitalise its E & E costs on an area of interest method.The following costs were incurred:Cash paid to acquire seismic study from government(GST exempt) 3,000Cash paid to acquire exploration rights(GST exempt) 10,000Cash paid to acquire fencing materials for an area-of-interest, including GST of $80 880Contractor fees for labour to set up the fencing, including GST of $50550Contractor fees for exploratory drilling, including GST $2,50027,500Hire of drilling equipment for contractor use, including GST of $5005,500Salary of project manager 60,000Stationery and other office supplies, including GST $30 330Gloaming company non executive directors fees paid 160,000Required:Which of the above costs can be capitalised as E& E assets?arrow_forward7.2 A machine with a purchase price of $9,000 is to be depreciated over its useful working life of 8 years to a book value of zero, using diminishing value depreciation. What is the amount of depreciation in Year 2? a. $1688 b. $1788 c. $1425 d. $1125 Clear my choicearrow_forward