Question

Problem 1: Depletion allowance

Gunslinger Oil Company purchased for $38,000,000 an oil well estimated to contain 1.2 million barrels of crude oil. When the oil is completely extracted, it is expected that the lead will be worth $1,400,000. A building and equipement costing $6,600,000 were constructed on the mine site, and they will be completely used up and have no salvage value when the oil is exhausted. During the first year, $78,000 barrels of oil was extracted, and $487,500 was spent for labor and other operating costs.

Instructions

(a) Compute the total cost per barrel of oil extracted for year 1 and year 2. (Show computations by setting up a schedule giving cost per barrel.)

(b) During the second year, operating costs and labor were $619,200 and Gunslinger extracted and sold 86,000 barrels of oil. Make the journal entry to record the depletion on December 31 under the direct method.

(c) What is the net book value of the Gunslinger oil well at the end of the second year assuming the use of an accumulated depletion account?

(d) Ignoring partial periods, make the journal entry for the depreciation expense on the building and equipement for the second year.

**Please give step by step process and equation of each part**

Answer 1

a.

	Year 1	Year 2
Total cost per barrel extracted	$43.42	$44.37

Working:

Year 1
Oil Extracted - barrels	78000
Depletion for the year (78,000 x $31.67)	2470000
Depreciation for the year (78,000 x $5.50)	429000
Labor and other operating costs	487500
Total cost for the year	3386500
Cost per barrel (3,386,500 / 78,000)	$43.42
Year 2
Oil Extracted - barrels	86000
Depletion for the year ($86,000 x 31.67)	2723333
Depreciation for the year (86,000 x $5.50)	473000
Labor and other operating costs	619200
Total cost for the year	3815533
Cost per barrel (3,815,553 / 86,000)	$44.37

Cost of the oil well	38000000
Estimated oil reserves - Barrels	1200000
Depletion rate per barrel	$31.67
Cost of building and equipment	6600000
Depreciation rate per barrel	$5.50

c.

Net book value of the oil well

32806667

Working:

Cost of the oil well		38000000
Depletion :
Year 1	2470000
Year 2	2723333	5193333
Net book value of the oil well		32806667

d.

Entry to record depreciation on building and equipment
Date	Account Title	Debit	Credit
Dec.31, Year 2	Depreciation Expense - Bldg.and Eqpt.	473000
	Accumulated Depreciation - Bldg.and Eqpt.		473000
	(Depreciatio for the year )