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 $11.0 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 $ 4,200,000 Mining equipment 146,000 Construction of various structures on site 121,500 After the minerals are removed from the mine, the equipment will be sold for an estimated residual value of $11,000. The structures will be torn down. Geologists estimate that 900,000 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 $ 700,000 30% 800,000 40% 900,000 30% Hecala’s credit-adjusted risk-free interest rate is 9%. During 2021, Hecala extracted 130,000 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 900,000 to 1,100,000 tons. Calculate the depletion of the mine and depreciation of the mining facilities and equipment for 2022 assuming Hecala extracted 160,000 tons of ore in 2022.
Solution
Hecala Mining
Mining site cost |
$11,000,000 |
Restoration costs - |
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Development costs |
$4,200,000 |
[(700,000 x 30%) + (800,000 x 40%) + (900,000 x 30%)] x (P/F, 9%, 4) |
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Restoration Costs |
$566,720 |
$800,000 x (P/F, 9%, 4) = 800,000 x 0.7084 = $566,720 |
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Cost of the mine |
$15,766,720 |
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Depletion = cost of mine per ton x tons extracted
= ($15,766,720/900,000 tons) x 130,000 tons
Depletion = 2,277,415
Depreciation – Machinery
Depreciation = (depreciable base/estimated tons) x tons extracted
Depreciable base = cost – residual value
= 146,000 – 11,000 = $135,000
Depreciation rate = $135,000/900,000 tons = $0.15 per ton
Depreciation expense = $0.15 x 130,000 tons = $19,500
Hence, machinery depreciation expense = $19,500
Depreciation – Structures
Depreciation = (cost/estimated tons) x tons extracted
= ($121,500/900,000 tons) x 130,000 tons
= $17,550
Hence, depreciation expense – structures = $17,550
Accretion expense = restoration cost x risk free interest rate x 8/12 months
= $800,000 x 9% x 8/12 = $48,000
Estimated mine = 1,100,000 tons; extracted mine = 160,000 tons
Depletion –
Cost of mine = $15,766,720
Less: depletion 2021 = $2,277,415
Book value at start of 2022 = $13,489,305
Revised estimates of tons remaining = 1,100,000 – 130,000 = 970,000 tons
Depletion rate = $13,489,305/970,000 = $13.9065 per ton
Tons extracted in 2022 = 160,000
Depletion 2022 = $13.9065 x 160,000 = $2,225,040
Depletion for 2022 = $2,225,040
Depreciation of machinery –
Book value at start of 2022 = depreciable base – depreciation 2021
= $135,000 - $19,500 = $115,500
Revised estimate of tons remaining = 970,000
Depreciation rate = $115,500/970,000 = $0.11907
Depreciation expense = 160,000 x $0.11907 = $19,052
Machinery Depreciation expense, 2022 = $19,052
Depreciation of structures –
Book value at start of 2022 = $121,500 – 17,550 = $103,950
Revised estimate of tons remaining = 970,000 tons
Depreciation rate = $103,950/970,000 = $0.10716
Depreciation expense 2022 = $0.10716 x 160,000 tons = $17,146
Structures Depreciation expense 2022 = $17,146
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