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Chapter 11: Q20E. (page 588)

(Depletion Computations鈥擮il) Diderot Drilling Company has leased property on which oil has been discovered. Wells on this property produced 18,000 barrels of oil during the past year that sold at an average sales price of \(55 per barrel. Total oil resources of this property are estimated to be 250,000 barrels.

The lease provided for an outright payment of \)500,000 to the lessor (owner) before drilling could be commenced and an annual rental of \(31,500. A premium of 5% of the sales price of every barrel of oil removed is to be paid annually to the lessor. In addition, Diderot (lessee) is to clean up all the waste and debris from drilling and to bear the costs of reconditioning the land for farming when the wells are abandoned. The estimated fair value, at the time of the lease, of this clean-up and reconditioning is \)30,000.

Instructions

From the provisions of the lease agreement, you are to compute the cost per barrel for the past year, exclusive of operating costs, to Diderot Drilling Company. (Round to the nearest cent.)

Short Answer

Expert verified

The total cost per barrel is $6.62.

Step by step solution

01

Meaning of Depletion

Depletion measures the amount of natural resources that have been tapped over time. Accounting and tax reporting could be aided by depletion, much like devaluation. The most noticeable impact of depletion is on mining, lumber, petroleum, and the exploitation and utilization of common assets.

02

Computing the cost per barrel for the past year.

Working notes:

Computation of amount of initial payments

Computation of Rental amount

Computing amount of premium

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Most popular questions from this chapter

Silverman Company purchased machinery for \(162,000 on January 1, 2017. It is estimated that the machinery will have a useful life of 20 years, salvage value of \)15,000, production of 84,000 units, and working hours of 42,000. During 2017, the company uses the machinery for 14,300 hours, and the machinery produces 20,000 units. Compute depreciation under the straight-line, units-of-output, working hours, sum-of-the-years鈥�-digits, and double-declining-balance methods.

(Unit, Group, and Composite Depreciation) The certified public accountant is frequently called upon by management for advice regarding methods of computing depreciation. Of comparable importance, although it arises less frequently, is the question of whether the depreciation method should be based on consideration of the assets as units, as a group, or as having a composite life.

Instructions

  1. Briefly describe the depreciation methods based on treating assets as

(1) units and

(2) a group or as having a composite life.

  1. Present the arguments for and against the use of each of the two methods.
  2. Describe how retirements are recorded under each of the two methods.

Electroboy Enterprises, Inc. operates several stores throughout the western United States. As part of an operational and financial reporting review in a response to a downturn in its markets, the company鈥檚 management has decided to perform an impairment test on five stores (combined). The five stores鈥� sales have declined due to aging facilities and competition from a rival that opened new stores in the same markets. Management has developed the following information concerning the five stores as of the end of fiscal 2016.

Original cost \(36million

Accumulated depreciation \)10 million

Estimated remaining useful life 4 years

Estimated expected future

annual cash flows (not discounted) \(4.0 million per year

Appropriate discount rate 5 percent

Accounting

  1. Determine the amount of impairment loss, if any, that Electroboy should report for fiscal 2016 and the book value at which Electroboy should report the five stores on its fiscal year-end 2016 balance sheet. Assume that the cash flows occur at the end of each year.
  2. Repeat part (a), but instead assume that (1) the estimated remaining useful life is 10 years, (2) the estimated annual cash flows are \)2,720,000 per year, and (3) the appropriate discount rate is 6 percent.

Analysis

Assume that you are a financial analyst and you participate in a conference call with Electroboy management in early 2017 (before Electroboy closes the books on fiscal 2016). During the conference call, you learn that management is considering selling the five stores, but the sale won鈥檛 likely be completed until the second quarter of fiscal 2017. Briefly discuss what implications this would have for Electroboy鈥檚 2016 financial statements. Assume the same facts as in part (b) above.

Principles

Electroboy management would like to know the accounting for the impaired asset in periods subsequent to the impairment. Can the assets be written back up? Briefly discuss the conceptual arguments for this accounting.

(Depreciation for Partial Periods鈥擲L, Act., SYD, and DDB) On January 1, 2015, a machine was purchased for \(90,000. The machine has an estimated salvage value of \)6,000 and an estimated useful life of 5 years. The machine can operate for 100,000 hours before it needs to be replaced. The company closed its books on December 31 and operates the machine as follows: 2015, 20,000 hours; 2016, 25,000 hours; 2017, 15,000 hours; 2018, 30,000 hours; and 2019, 10,000 hours.

Instructions

(a) Compute the annual depreciation charges over the machine鈥檚 life assuming a December 31 year-end for each of the following depreciation methods.

  1. Straight-line method.
  2. Activity method.
  3. Sum-of-the-years鈥�-digits method.
  4. Double-declining-balance method.

(b) Assume a fiscal year-end of September 30. Compute the annual depreciation charges over the asset鈥檚 life applying each of the following methods.

  1. Straight-line method.
  2. Sum-of-the-years鈥�-digits method.
  3. Double-declining-balance method

(Depletion Computations鈥擳imber) Stanislaw Timber Company owns 9,000 acres of timberland purchased in 2006 at a cost of \(1,400 per acre. At the time of purchase, the land without the timber was valued at \)400 per acre. In 2007, Stanislaw built fire lanes and roads, with a life of 30 years, at a cost of \(84,000. Every year, Stanislaw sprays to prevent disease at a cost of \)3,000 per year and spends \(7,000 to maintain the fire lanes and roads. During 2008, Stanislaw selectively logged and sold 700,000 board feet of timber of the estimated 3,500,000 board feet. In 2009, Stanislaw planted new seedlings to replace the trees cut at a cost of \)100,000.

Instructions

  1. Determine the depreciation expense and the cost of timber sold related to depletion for 2008.
  2. Stanislaw has not logged since 2008. If Stanislaw logged and sold 900,000 board feet of timber in 2019, when the timber cruise (appraiser) estimated 5,000,000 board feet, determine the cost of timber sold related to depletion for 2019.
See all solutions

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