Question

Gem Limited commences operations on 1 January 2019. During 2019 Gem Limited explores three areas and incurs the following costs: Exploration and Evaluation expenditure ($) Desirable 25,000,000 Undesirable 20,000,000 Neutral 28,000,000 In 2020 oil is discovered at Desirable Site. Undesirable Site is abandoned. Neutral Site has not yet reach a stage that permits a reasonable assessment at the existence or otherwise of economically recoverable reserves, and active and significant operations in the area of interest are continuing. In relation to the exploration and evaluation expenditures incurred at Desirable Site and Neutral Site, 70 percent of the expenditures related to property, plant and equipment, and the balance relates to intangible assets. In 2020, development costs of $48,000,000 are incurred at Desirable Site (to be written off on a production basis). $32,000,000 of this expenditure relates to property, plant and equipment, and the balance relates to intangible assets. The development of Desirable Site is completed but the production is not started yet. (i.e. there is no production, inventory and sales)

Required: Provide the necessary journal entries using the area-of-interest method

Answer 1

Undesirable site:

Exploration and Evaluation expenditure of $20,000,000. Since the site has been abandoned, cost incurred on Exploration and Evaluation expenditure as per area-of-interest method needs to be written off in 2019. Following entries needs to be posted.

Expenditure account Debit $20,000,000

To Bank Credit $20,000,000

Neutral site:

Exploration and Evaluation expenditure of $28,000,000. Since Neutral Site has not yet reach a stage that permits a reasonable assessment at the existence or otherwise of economically recoverable reserves, and active and significant operations in the area of interest are continuing, the Exploration and Evaluation expenditure of $28,000,000 needs to be carried forward to next year 2020 basis the proportion mentioned i.e. 70% property, plant and equipment, and the balance relates to intangible assets.

Following entries needs to be posted.

Property, plant and equipment Debit $19,600,000

Intangible Assets Debit $8,400,000

To Bank Credit $28,000,000

Desirable site:

Exploration and Evaluation expenditure of $25,000,000. Since in 2020 oil is discovered at Desirable Site, the Exploration and Evaluation expenditure of $25,000,000 needs to be carried forward to next year 2020 basis the proportion mentioned i.e. 70% property, plant and equipment, and the balance relates to intangible assets.

Following entries needs to be posted.

Property, plant and equipment Debit $17,500,000

Intangible Assets Debit $7,500,000

To Bank Credit $25,000,000

Further, In 2020, development costs of $48,000,000 are incurred at Desirable Site (to be written off on a production basis). $32,000,000 of this expenditure relates to property, plant and equipment, and the balance relates to intangible assets. These cost needs to be accounted to their respective assets accounts and will be further carried forward in respect of the area of interest till expected to be recouped through successful exploitation of the area of interest, or alternatively, by its sale.

Following entries needs to be posted.

Property, plant and equipment Debit $32,000,000

Intangible Assets Debit $16,000,000

To Bank Credit $48,000,000