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 s not yet started.(i.e. there is no production , inventory and sale)

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

Answer 1

Gem ltd is engaged in the business of extracting oil. Such kind of entities incur huge amounts of expenditure in exploring and evaluation of several areas to identify potential areas which are useful for the exploration of oil.

There may be cases where many of such evaluated areas found unfruitful. The cost incurred on those areas will be written off as impairment loss.

The cost incurred on those areas which are identified suitable for exploration are then segregated between tangible ( property, plant and equipment) and intangible assets.

Those areas which the management has identified neither as abandoned nor extractable because of the level of further evaluation is required, will not be identified as tangible and intangible assets untill some assurance regarding the desirability has been obtained.

The journal entries in the books of Gem ltd are as follows: