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Chapter 11: Q11-26Q (page 583)

The following statement appeared in a financial magazine: 鈥淩RA鈥攐r Rah-Rah, as it鈥檚 sometimes dubbed鈥� has kicked up quite a storm. Oil companies, for example, are convinced that the approach is misleading. Major accounting firms agree.鈥� What is RRA? Why might oil companies believe that this approach is misleading?

Short Answer

Expert verified

Answer

Oil companies are concerned because the valuation issue is extremely tenuous.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of RRA

The SEC recommended Reserve Recognition Accounting (RRA) as a mechanism (a fair value approach) of accounting for oil and gas resources. According to proponents of this concept, oil and gas should be priced at the time of discovery. The reserve value that remains on earth is calculated, and this amount is recorded on the balance sheet as "oil deposits" after being correctly discounted.

02

Explaining the reasons for the approach that is misleading.

Oil firms are worried because the value situation is precarious. To appropriately evaluate reserves, for example, the following must be estimated:

  1. reserve value,
  2. future production costs,
  3. estimated disposal times,
  4. discount rate, and
  5. selling price.

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Most popular questions from this chapter

(Depreciation for Partial Periods鈥擲L, Act., SYD, and Declining-Balance) The cost of equipment purchased by Charleston, Inc., on June 1, 2017, is \(89,000. It is estimated that the machine will have a \)5,000 salvage value at the end of its service life. Its service life is estimated at 7 years, its total working hours are estimated at 42,000, and its total production is estimated at 525,000 units. During 2017, the machine was operated 6,000 hours and produced 55,000 units. During 2018, the machine was operated 5,500 hours and produced 48,000 units.

Instructions Compute depreciation expense on the machine for the year ending December 31, 2017, and the year ending December 31, 2018, using the following methods.

  1. Straight-line.
  2. Units-of-output.
  3. Working hours.
  4. 厂耻尘-辞蹿-迟丑别-测别补谤蝉鈥�-诲颈驳颈迟蝉.
  5. Declining-balance (twice the straight-line rate).

Tanaka Company has land that cost \(15,000,000. Its fair value on December 31, 2017, is \)20,000,000. Tanaka chooses the revaluation model to report its land. Explain how the land and its related valuation should be reported.

(Error Analysis and Depreciation, SL and SYD) Mike Devereaux Company shows the following entries in its Equipment account for 2018. All amounts are based on historical cost.

Equipment
2018
2018
Jan 1Balance 134,750June 30Cost of 23,000 equipment sold (purchased prior to 2018)
Aug. 10Purchases 32,000

12Freight on Equipment purchased 700

25Installation costs 2,700

Nov. 10Repairs 500

Instructions

  1. Prepare any correcting entries necessary.
  2. Assuming that depreciation is to be charged for a full year on the ending balance in the asset account, compute the proper depreciation charge for 2018 under each of the methods listed below. Assume an estimated life of 10 years, with no salvage value. The machinery included in the January 1, 2018, balance was purchased in 2016.

    a. Straight-line
    b. 厂耻尘-辞蹿-迟丑别-测别补谤蝉鈥�-诲颈驳颈迟蝉.

(Depreciation Computation鈥擜ddition, Change in Estimate) In 1990, Herman Moore Company completed the construction of a building at a cost of \(2,000,000 and first occupied it in January 1991. It was estimated that the building will have a useful life of 40 years and a salvage value of \)60,000 at the end of that time.

Early in 2001, an addition to the building was constructed at a cost of \(500,000. At that time, it was estimated that the remaining life of the building would be, as originally estimated, an additional 30 years and that the addition would have a life of 30 years and a salvage value of \)20,000.

In 2019, it is determined that the probable life of the building and addition will extend to the end of 2050, or 20 years beyond the original estimate.

Instructions

  1. Using the straight-line method, compute the annual depreciation that would have been charged from 1991 through 2000.
  2. Compute the annual depreciation that would have been charged from 2001 through 2018.
  3. Prepare the entry, if necessary, to adjust the account balances because of the revision of the estimated life in 2019.
  4. Compute the annual depreciation to be charged, beginning with 2019.

(Depreciation Choice鈥擡thics) Jerry Prior, Beeler Corporation鈥檚 controller, is concerned that net income may be lower this year. He is afraid upper-level management might recommend cost reductions by laying off accounting staff, including him.

Prior knows that depreciation is a major expense for Beeler. The company currently uses the double-declining-balance method for both financial reporting and tax purposes, and he鈥檚 thinking of selling equipment that, given its age, is primarily used when there are periodic spikes in demand. The equipment has a carrying value of \(2,000,000 and a fair value of \)2,180,000. The gain on the sale would be reported in the income statement. He doesn鈥檛 want to highlight this method of increasing income. He thinks, 鈥淲hy don鈥檛 I increase the estimated useful lives and the salvage values? That will decrease depreciation expense and require less extensive disclosure, since the changes are accounted for prospectively. I may be able to save my job and those of my staff.鈥�

Instructions

Answer the following questions.

  1. Who are the stakeholders in this situation?
  2. What are the ethical issues involved?
  3. What should Prior do?
See all solutions

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