Depreciation and depletion; change in useful life; asset retirement obligation
Response to the following problem:
On May 1, 2016, 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 million. Additional costs and purchases included the following:
Development costs in preparing the mine $3,200,000
Mining equipment 140,000
Construction of various structures on site 68,000
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 800,000 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 |
|
$600,000
|
30%
|
|
700,000
|
30%
|
|
800.000
|
40%
|
Hecala's credit-adjusted risk-free interest rate is 8%. During 2016, Hecala extracted 120,000 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 2016, assuming that Hecala uses the units-of-production method for both depreciation and depletion. Round depletion and depreciation rates to four decimals.
3. How much accretion expense will the company record in its income statement for the 2016 fiscal year?
4. Are depletion of the mine and depreciation of the mining facilities and equipment reported as separate expenses in the income statement? Discuss the accounting treatment of these items in the income statement and balance sheet.
5. During 2017, Hecala changed its estimate of the total amount of ore originally in the mine from 800,000 to 1,000,000 tons. Briefly describe the accounting treatment the company will employ to account for the change and calculate the depletion of the mine and depreciation of the mining facilities and equipment for 2017 assuming Hecala extracted 150,000 tons of ore in 2017.