Ch 10 - Appendix B: Journalizing Adjusting Entries for Depletion
Remember, the adjusting entry for depreciation, regardless of the method used to calculate depreciation was:
| Depreciation Expense | Debit | |
| Accumulated Depreciation | Credit |
| Depletion Expense | Debit | |
| Accumulated Depletion | Credit |
Computing periodic depletion cost To compute depletion charges, companies usually use the units-of-production method. They divide total cost by the estimated number of units—tons, barrels, or board feet—that can be economically extracted from the property. This calculation provides a per-unit depletion cost. For example, assume that in 2015 a company paid $ 650,000 for a tract of land containing ore deposits. The company spent $ 100,000 in exploration costs. The results indicated that approximately 900,000 tons of ore can be removed economically from the land, after which the land will be worth $50,000. The company incurred costs of $200,000 to develop the site, including the cost of running power lines and building roads. Total cost subject to depletion is the net cost assignable to the natural resource plus the exploration and development costs. When the property is purchased, a journal entry assigns the purchase price to the two assets purchased—the natural resource and the land. The entry would be:
|
Land |
Debit 50,000 |
Credit |
| Ore Deposits | 600,000 | |
| Cash | 650,000 | |
| To record purchase of land and mine. |
|
Ore Deposits ($100,000 + $200,000) |
Debit 300,000 |
Credit |
| Cash | 300,000 | |
| To record costs of exploration and development. |
- Calculate depletion cost per unit (Cost - salvage or residual value) / total amount expected to be used over its lifetime
- Calculate depletion expense (units used this period x depletion per unit)
In some instances, companies buy only the right to extract the natural resource from someone else’s land. When the land is not purchased, its residual value is irrelevant and should be ignored. If there is an obligation to restore the land to a usable condition, the firm adds these estimated restoration costs to the costs to develop the site.
In the example where the land was purchased, the total costs of the mineral deposits equal the cost of the site ($ 650,000) minus the residual value of land ($ 50,000) plus costs to develop the site ($ 300,000), or a total of $900,000. The unit (per ton) depletion charge is $ 1 (or $ 900,000 cost /900,000 tons). If 100,000 tons are mined in 2015, this entry records the depletion cost of $100,000 ($1 depletion per unit X 100,000 tons mined) for the period:
|
Depletion Expense |
Debit 100,000 |
Credit |
| Accumulated Depletion—Ore Deposits | 100,000 | |
| To record depletion for 2015. |
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