McCurdy Oil acquired an existing oil well and all related equipment used in the
ID: 2569081 • Letter: M
Question
McCurdy Oil acquired an existing oil well and all related equipment used in the production of oil. McCurdy paid $2,500,000, of which 20% was attributable to pumps, pipelines, and tanks. The oil well is expected to produce oil as follows:
Year 1 100 barrels per day
Year 2 80 barrels per day
Year 3 60 barrels per day
Year 4 40 barrels per day
Year 5 20 barrels per day
At the end of the 5th year, McCurdy anticipates selling the oil well and equipment for $1,000,000. Of this amount, $250,000 is expected to be attributable to the equipment.
Assuming the preceding estimates serve as the basis for depletion, calculate depletion cost for the 3rd year. Prepare an approriate journal entry for depletion. In preparing the entry, assume that all oil is sold at the time of its production (i.e., none of the oil remains in inventory).
GENERAL JOURNAL
Date Accounts Debit Credit
Year 3
To record depletion of oil well
Explanation / Answer
In given case, Mc curdy’s acquisition cost is $2500,000 which is the depletion base. This depletion base shall be depleted over the 5 years of extraction period on the basis of number of barrels extracted during the year.The salvage value of the mine is $1000,000.
The formula to calculate depletion for a year shall be:
Depletion Expense = (Cost Salvage Value) ×Number of Units Extracted / Estimated Number of Units
Calculation of number of barrels expected to be extracted during the whole 5 years period and during 3rd year :
Year barrels per day barrels for the year
1 100 365*100 = 36,500
2 80 365*80 = 29,200
3 60 365*60 = 21,900
4 40 365*40 = 14,600
5 20 365*20 = 7,300
Total barrels = 109,500
Applying above formula depletion cost for 3rd year
= ($2,500,000-$1,000,000)*21900/109500
=$1500, 000 *21900/109500
=$300,000.
Note:
The pipeline ,pumps and tank costs are also part of acquisition cost of the mine and are necessary to prepare the mine for oil extraction and so should form part of the depletion base.
Journal entry:
Date Accounts Debit Credit
Year 3 Depletion expense $300,000
Oil well (asset) $300,000