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 $9.3 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 $ 2,500,000 Mining equipment 143,400 Construction of various structures on site 36,500 After the minerals are removed from the mine, the equipment will be sold for an estimated residual value of $12,000. The structures will be torn down. Geologists estimate that 730,000 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 $ 530,000 40% 630,000 30% 730,000 30% Hecala’s credit-adjusted risk-free interest rate is 7%. During 2021, Hecala extracted 113,000 tons of ore from the mine. The company’s fiscal year ends on December 31.

Required:

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 730,000 to 930,000 tons. Calculate the depletion of the mine and depreciation of the mining facilities and equipment for 2022 assuming Hecala extracted 143,000 tons of ore in 2022.

Answer 1

2. Note 1 - Cost Of the mine will be Computed as follows :

Particulars	Amount ( $ )
Purchase price of the right to use the mine	9,300,000
Development cost in preparing the mine	2,500,000
Present value of restoration cost ( Note 2 )	472,998
Total	122,729,98

Note 2 - For finding the restoration cost, possible outflows of  restoration cost is given in the problem. The restoration cost will be expected value of this possible outflows.

Therefore restoration cost = (530000*40%)+(630000*30%)+(730000*30%) = $ 620,000

Present value of $ 1 @ 7 % for 4 years = 1 / ( 1 + i )n = 1 / ( 1 + .07)4 = 0.7629

Therefore , Present value of restoration cost = $ 620,000 * 0.7629 = $ 4,72,998

Depreciation and depletion expenses for 2021

Unit of production method is used for computing depreciation and depletion.

Depreciation or Depletion = Original Cost / Total Cost * units extracted during the year

                                                                Total units will be extracted

a) i) Original Cost recorded in the mine = $ 122,729,98 ( Note 1 )

            ii) Total tons of ore extracted in the year 2021 = 113000 tons

            iii) Total tons of ore extracted in the life of the mine = 730000 tons

Therefore, Depletion for the mine for the year 2021= 122,729,98 *113000

                                                                                            730000                 = $ 1899792.84 Or 1899793 ( approx )

b) i) Original Cost for equipment = Cost of purchase - salvage value at the end of mining process    = $ 143400 -$12000 = $131400

ii) Depreciation for equipment = 131400 *113000

730000                          = $ 20340

c) i) Depreciation base for structures = cost of structures for construction = $ 36500

            ii) Therefore depreciation for structures = 36500 * 113000

730000                 = $ 5650

To summarize it in a table :

Depletion of Mine	1899793
Depreciation expense for equipment	20340
Depreciation of structures	5650

3. Accretion expense is the ongoing, scheduled recognition of an expense related to a long-term liability.

The concept is most commonly applied to asset retirement obligations , which usually extend for many years into the future, and so are measured using a discounted cash flows analysis.

Present value of restoration cost ( Note 2 )	$ 472,998
The accretion expense to be recorded this period =	472,998 * 7 % * 8 * / 12
Note 3 – Since this project is started in may and year end is December = 8 months

4. Depreciation and Depletion both have similar accounting concepts but are used for different asset / company types.

Depreciation is the accounting term used for assets such as buildings, furniture and fittings, equipment etc.

Whereas , Depletion is an accounting concept which is used mostly in mining, timber, petroleum or other similar industries.

In a way we can say that, depreciation is for tangible assets and depletion is for Intangible Assets which are physically exhaustible Like mines.

In the Income Statement they are shown in one single Line – Depreciation , Depletion and Amortization , with related notes in schedules ..So the answer will be YES , THEY ARE SHOWN SEPARATELY AS A PART OF COST OF GOODS SOLD ..

5. Depreciation and depletion expenses for 2022

Unit of production method is used for computing depreciation and depletion.

Depreciation or Depletion = Original Cost / Total Cost * units extracted during the year

                                              Total Revised units will be extracted – Extracted in 2021

a) i) Revised Cost recorded in the mine in 2022 =Original Cost – Depletion of 2021 = $ 122,729,98 ( Note 1 ) – 1899793 = 10373205

            ii) Total tons of ore extracted in the year 2022 = 143000 tons

            iii) Total tons of ore extracted in the life of the mine = 930000 tons

Remaining ore can be extracted = New estimation of ore to be extracted - ore extracted during 2021 = 930000 – 113000 = 817000 ( Revised Base )

Therefore, Depletion for the mine for the year 2022= 10373205 *143000

                                                                                            817000         = $ 1815628.29

Or 1815628 ( approx )

b) i) Revised Cost for equipment = Original Cost – Depreciation of 2022

                                                  = $ 131400 – 20340 = $ 111060

ii) Depreciation for equipment = 111060 *143000

817000   = $ 19438.89 or 19439

c) i) Depreciation base for structures = Original Cost – Depreciation of 2022

          = $ 36500 – 5650 = $ 30850

            ii) Therefore depreciation for structures =   30850 * 143000

817000    = $ 5399.69 or 5400

To summarize it in a table :

Depletion of Mine	1815628
Depreciation expense for equipment	19439
Depreciation of structures	5400