Question

On May 1, 2018, 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 2018, 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 2018, 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 2018 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 2019, 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 2019 assuming Hecala extracted 156,000 tons of ore in 2019.

Answer 1

Requirement 1

The mine should be recorded at cost. The cost shall include right to use, development cost, restoration cost and cost of bringing it to original condition after use.

Purchase price of the right to use the mine = $ 10,600,000

Development cost in preparing the mine = $ 3,800,000

Therefor restoration cost = (660,000*30%)+(760,000*30%)+(860,000*40%) = $ 770,000

Therefore, Cost of mine = $ 10,600,000+$ 3,800,000+$ 770,000= $ 15,170,000

Requirement 2

Depreciation and depletion expenses for 2018

Here, units of production method shall be used for depletion computation

Depreciation or Depletion = Depletion/ Depreciation base * units extracted during the year/ Total units will be extracted

Depletion base for the mine = Cost recorded in the mine = $ 15,170,000

Total tons of ore extracted in the year 2018 = 126,000 tons

Total tons of ore extracted in the life of the mine = 860,000 tons

Depletion for the mine for the year 2018= (15,170,000/860,000) * 126,000 =$ 2,142,000

Depreciation base for equipment = Cost of purchase - salvage value at the end of mining process

= $ 156,200 -$10000 =$146,200

Depreciation for equipment = (146,200/860,000) *126000 = 21,420

Depreciation base for structures = cost of structures for construction = $ 98,900

Therefore, depreciation for structures for the year 2018 = (98,900/860,000) *126000 = 14,490

	Amount
Depletion	2142,000
Depreciation expense for equipment	21,420
Depreciation of structures	14,490

Requirement 3

restoration cost = (660,000*30%)+(760,000*30%)+(860,000*40%) = $ 770,000

Accretion expense to be recorded = 770,000 * (1/1.08)^4 =$ 565,873

Requirement 4

The depletion and depreciation needs to be recorded separately as depreciation is provided for plant assets whereas depletion is for natural resources. Depletion depicts the gradual exhaustion of reserves of natural resources whereas depreciation depicts wearing out of tangible assets over its useful life.

Requirement 5

In year 2019, Hecala changed its estimate which warrants re-computation of depletion for the year.

Depreciation or Depletion = Depletion/ Depreciation base * units extracted during the year/ Total units will be extracted

Depletion base for mine = Cost of the mine - depreciation for 2018 = $ 15,170,000-$ 2142,000 = 13,028,000

Remaining ore can be extracted = New estimation of ore to be extracted - ore extracted during 2018

= 1060,000 – 126,000 = 934,000 tons

Ore extracted in 2019= 156,000 tons

Therefore, Depletion of the mine for 2019 = (13028,000/934,000) *156,000 = 2,175,981.6

Depreciation base for equipment = Cost of purchase - salvage value at the end of mining process

= $ 156,200 -$10000 =$146,200

Depreciation base for the equipment in 2019 = base in 2018- depreciation in 2018= $146,200 – 21420 = 124,780

Depreciation of equipment for 2019 = (124780/934,000) *156,000 = 20826

Depreciation base for structures for 2019 = cost - depreciation for 2018= $ 98900 – 14490 = 84,410

Depreciation of structures for 2019 = (84410/934,000) *156,000 =14086.80

	Depreciation for 2019
Depletion	2,175,981.6
Depreciation expense for equipment	20826
Depreciation of structures	14086.80