(Depletion and Depreciation—Mining) Khamsah Mining Company has purchased a tract of mineral land for \(900,000. It is estimated that this tract will yield 120,000 tons of ore with sufficient mineral content to make mining and processing profitable. It is further estimated that 6,000 tons of ore will be mined the first and last year and 12,000 tons every year in between. (Assume 11 years of mining operations.) The land will have a salvage value of \)30,000.

The company builds necessary structures and sheds on the site at a cost of \(36,000. It is estimated that these structures can serve 15 years but, because they must be dismantled if they are to be moved, they have no salvage value. The company does not intend to use the buildings elsewhere. Mining machinery installed at the mine was purchased secondhand at a cost of \)60,000. This machinery cost the former owner $150,000 and was 50% depreciated when purchased. Khamsah Mining estimates that about half of this machinery will still be useful when the present mineral resources have been exhausted, but that dismantling and removal costs will just about offset its value at that time. The company does not intend to use the machinery elsewhere. The remaining machinery will last until about one-half the present estimated mineral ore has been removed and will then be worthless. Cost is to be allocated equally between these two classes of machinery.

Instructions

1. As chief accountant for the company, you are to prepare a schedule showing estimated depletion and depreciation costs for each year of the expected life of the mine.
2. Also compute the depreciation and depletion for the first year assuming actual production of 5,000 tons. Nothing occurred during the year to cause the company engineers to change their estimates of either the mineral resources or the life of the structures and equipment.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Depletion

Depletion is defined as a reduction in the quantity of a production factor due to the manufacturing process. Companies generate new products by combining current goods and services. When old items are turned into new products, it is termed as production process.

02

(a) Preparing schedule showing estimated depletion and depreciation

Calculating estimated depletion

Estimated depletion
Depletion Base	Estimated Yield	Per Ton	1st and 11th year	Each of years 2-10 incl.
$870,000	120,000 tons	$7.25	$43,500	$87,000

Working Notes:

Calculating Depletion base amount

$\begin{array}{c}\text{Depletion\hspace{0.17em}base}=\text{Cost\hspace{0.17em}of\hspace{0.17em}land}-\text{Salvage\hspace{0.17em}value}\\ =\mathrm{\$}900,000-\mathrm{\$}30,000\\ =\mathrm{\$}870,000\end{array}$

Calculating 1^st and 11th-year depletion amount

$\begin{array}{c}\text{Estimated\hspace{0.17em}depletion}=\text{Estimated\hspace{0.17em}tonsmined}\times \text{Per\hspace{0.17em}ton}\\ =6,000\times \mathrm{\$}7.25\\ =\mathrm{\$}43,500\end{array}$

Calculation of depreciation each of years 2-10 inclusive.

$\begin{array}{c}\text{Estimated\hspace{0.17em}depletion}=\text{Total\hspace{0.17em}tons\hspace{0.17em}mined}\times \text{Per\hspace{0.17em}ton}\\ =12,000\times \mathrm{\$}7.25\\ =\mathrm{\$}87,000\end{array}$

Calculating estimated depreciation

Asset	Cost	Per ton Mined	1st Yr.	Yrs. 2–5	6th Yr.	Yrs. 7–10	11th Yr.
Building	$36,000	$.30	$1,800	$3,600	$3,600	$3,600	$1,800
Machinery (1/2)	30,000	0.25	1,500	3,000	3,000	3,000	1,500
Machinery (1/2)	30,000.	0.50	3,000	6,000	3,000	0	0

Calculation of per ton mined of building

$\begin{array}{c}\text{Per\hspace{0.17em}ton\hspace{0.17em}mined}=\frac{\text{Cost}}{\text{Total\hspace{0.17em}ton\hspace{0.17em}yield}}\\ =\frac{\mathrm{\$}36,000}{120,000}\\ =\mathrm{\$}0.30\end{array}$

Calculation of per ton mined of machinery

$\begin{array}{c}\text{Per\hspace{0.17em}ton\hspace{0.17em}mined}=\frac{\text{Cost}}{\text{Total\hspace{0.17em}ton\hspace{0.17em}yield}}\\ =\frac{\mathrm{\$}30,000}{120,000}\\ =\mathrm{\$}0.25\end{array}$

Calculation of per ton mined of machinery

$\begin{array}{c}\text{Per\hspace{0.17em}ton\hspace{0.17em}mined}=\frac{\text{Cost}}{\frac{\text{Total\hspace{0.17em}ton\hspace{0.17em}yield}}{2}}\\ =\frac{\mathrm{\$}30,000}{\frac{120,000}{2}}\\ =\mathrm{\$}0.50\end{array}$

03

(b) Computing depreciation and depletion for the first year

Calculating the amount of depletion

$$\begin{gathered} \text{Depletion}=\text{Actual\hspace{0.17em}production}\times \text{Per\hspace{0.17em}ton} \\ =5,000\times \mathrm{\$}7.25 \\ =\mathrm{\$}36,250 \end{gathered}$$

Calculating the amount of depreciation

Depreciation:
Building $.30 5,000	$1,500
Machinery $.25 5,000	1,250
Machinery $.50 5,000	2,500
Total depreciation	$5,250

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