Question

At the beginning of 2003, Firm X paid $80,000 for a piece of property with 1,000 acres of timber. The firm estimated that a total of 30,000 trees could ultimately be removed from this site. They estimated that the land could be sold for $10,000 after completion of the project.

During 2003, Firm X spent $150,000 on labor to help with the cutting and treatment of the timber (intangible development cost). It also purchased a piece of equipment for $20,000 to help with the extraction (tangible development cost). The equipment had a 10‐year life and would be used for a different project after completing work on the current project.

During 2003, the firm extracted 10,000 trees, and sold 8,000 of these trees. At that time, the firm estimated that an additional 20,000 trees could still be extracted.

In 2004, Firm X spent an additional $12,000 to help extract more trees. Firm X extracted an additional 11,000 trees, and sold a total of 5,000 trees. At that time, the firm estimated that an additional 9,000 trees could still be extracted.

Calculate the unit depletion rate for 2003 and for 2004.

Answer 1

Computation of depreciation under depletion method.

Year 2003

Step 1: Determination of the depletion base

Depletion Base = Cost to Acquire + Cost to Explore + Cost to Develop

• Acquisition: Price paid for known resources or the rights to search and discover a natural resource. Firm X paid $80,000 for a piece of property with 1,000 acres of timber. So, Acquisition cost is $80,000.
• Exploration: Costs associated with discovering a natural resource. As the timber trees are readily available, there is no cost of exploration.
• Development: Costs associated with extracting a resource. These fall into two categories: Intangible and tangible development costs.

Tangible costs mean cost of physical assets needed to extract the resource, like drills, and other heavy equipment. Tangible costs are NOT included in the depletion base, they are depreciated as other property, plant, and equipment. Firm X purchased a piece of equipment for $20,000 to help with the extraction (tangible development cost). This is not considered as it is a tangible cost.

Intangible assets include those costs associated with gaining access to the natural resource like drilling, or otherwise. Intangible assets are included as part of the depletion base. Firm X spent $150,000 on labour to help with the cutting and treatment of the timber (intangible development cost). So, it is to be included.

Hence, Development cost is $150,000.

Depletion Base = Cost to Acquire + Cost to Explore + Cost to Develop

                                    = 80,000 + 0 + 150,000

                                    = 230,000

Step 2: Computation of depletion rate per unit: This is calculated by dividing the depletion base less salvage value (if any) by the number of units expected to be extracted. Firm X estimated that the land could be sold for $10,000 after completion of the project. So, Salvage value is $10,000. The firm estimated that a total of 30,000 trees could ultimately be removed from this site. So, No. of Units are 30,000

Unit Depletion rate = (Depletion base – Salvage value) / Total units expected to be extracted.

                                    = (230,000 – 10,000) / 30,000

                                    = 220,000 / 30,000

                                    = 7.33 per unit (approx.)

Depletion charge for the period = Units extracted during the period × Depletion rate

                                                                        = 10,000 x 7.33

                                                                        = 73,300

Year 2004

In 2004, Firm X spent an additional $12,000 to help extract more trees. As the $12,000 of development costs were incurred they were capitalized to the cost of the property and included in the depletion base.

So, new depletion Base = 230,000 + 12,000 – 73,300

                                          = 168,700

Total units expected to be extracted = 20,000

Unit Depletion rate = (Depletion base – Salvage value) / Total units expected to be extracted.

                                    = (168,700 – 10,000) / 20,000

                                    = 158,700 / 20,000

                                    = 7.935 per unit (approx.)

Depletion charge for the period = Units extracted during the period × Depletion rate

                                                     = 11,000 x 7.935

                                                     = 87,285