Question

On May 1, 2021, 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 $10.6 million. Additional costs and purchases included the following (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.):

Development costs in preparing the mine	$	3,800,000
Mining equipment		156,200
Construction of various structures on site		98,900

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 860,000 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:

Cash Outflow				Probability
$	660,000			30%
	760,000			30%
	860,000			40%

Hecala’s credit-adjusted risk-free interest rate is 8%. During 2021, Hecala extracted 126,000 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 2021, assuming that Hecala uses the units-of-production method for both depreciation and depletion.
3. How much accretion expense will the company record in its income statement for the 2021 fiscal year?
4. Are depletion of the mine and depreciation of the mining facilities and equipment reported as separate expenses in the income statement?
5. During 2022, Hecala changed its estimate of the total amount of ore originally in the mine from 860,000 to 1,060,000 tons. Calculate the depletion of the mine and depreciation of the mining facilities and equipment for 2022 assuming Hecala extracted 156,000 tons of ore in 2022.

Answer 1

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Hecala Mining Requirement 1 The calculation of amount at which mine will be recorded: 10600000 3800000 Mining cost Development cost Restoration cost: $660,000 * 30% $760,000 * 30% $860,000 * 40% Total 198000 228000 344000 770000 Restoration cost = $770,000 * 0.735 = $565,950 (Present value of $1, n = 4, I = 8%) Therefore, Cost of mine = Mining cost + Development cost + Restoration cost = $10,600,000 + $3,800,000 + $565,950 = $14,965,950 Requirement 2 Calculation of depletion of mine & the dep. of mining facilities & equipment: Depletion of mine = (Cost of mine / estimated tons of ore) * actual tons of ore = ($14,965,950/860,000) x 126,000 = 2192686 Depreciation of machinery = ((Mining equipment - residual value)/ estimated tons of ore) * actual tons of ore = (($156,200 - $10,000)/860,000) * 126,000 = 21420 Depreciation of structure = (Cost / estimated tons of ore) * actual tons of ore = (98,900/860,000) * 126,000 = 14490

Requirement 3 Computation of accretion expense: Accretion expense = Restoration cost * rate * no. of months = $565,950 * 8% *(8/12) = 30184 Requirement 4 The depletion and depreciation are included in COGS in the income statement when minerals are sold. Requirement 5 Depletion: Original cost 14965950 Less: 2021 depletion 2192686 Remaining depletable base 12773264 Revised estimated tons remaining = 1060000 - 126000 = 934000 Depletion rate = Remaining depletable cost / Estimated tons remaining = 12773264 / 934000 = 13.68 Extracted = 156000 Depletion for 2022 = 156000 x 13.68 = 2132520 Depreciation of machinery Depreciable base = Cost - Depreciation - Residual value = (156200 - 21420 - 10000) = 124780 Depreciation rate = Depreciable base / Estimated tons remaining = 124780 / 934000 = 0.1336 Depreciation of 2022 = 0.1336 * 156,000 = 20841.2 Depreciation of structure Depreciable base = Cost - dep. = 98900 - 14490 = 84410 Revised estimated tons = 1060000 Dep rate = 84410 / 1060000 = 0.0796 2022 Dep. = 0.0796 x 156000 = 12422.6