HW Chap 11 Day 2
ANSWERS TO QUESTIONS
23. Cost depletion is the procedure by which the capitalized costs, less residual land values, of a
natural resource are systematically charged to operations. The purpose of this procedure is
to match the cost of the resource with the revenue it generates. The usual method is to
divide the total cost less residual value by the estimated number of recoverable units to
arrive at a depletion charge for each unit removed. A change in the estimate of recoverable
units will necessitate a revision of the unit charge.
Percentage depletion is the procedure, authorized by the Internal Revenue Code, by which a
certain percentage of gross income is charged to operations in arriving at taxable income.
Percentage depletion is not considered to be a generally accepted accounting principle
because it is not related to the cost of the asset and is allowed even though the property is
fully depleted under cost depletion accounting. Applicable rates, ranging from 5% to 22% of
gross income, are specified for nearly all natural resources. The total amount deductible in
a given year may not be less than the amount computed under cost depletion procedures,
and it may not exceed 50% of taxable income from the property before the depletion
deduction. Cost depletion differs from percentage depletion in that cost depletion is a function
of production whereas percentage depletion is a function of income.
Percentage depletion has arisen, in part, from the difficulty of valuing the natural resource
or determining the discovery value of the asset and of determining the recoverable units.
Although other arguments have been advanced for maintaining percentage depletion, a
primary argument is its value in encouraging the search for additional resources. It is
deemed to be in the national interest to provide an incentive to the continuing search for
natural resources. As noted in the textbook, percentage depletion is no longer permitted for
many enterprises.
26. Reserve recognition accounting (RRA) is the method that was proposed by the SEC to
account for oil and gas resources. Proponents of this approach argue that oil and gas
should be valued at the date of discovery. The value of the reserve still in the ground is
estimated and this amount, appropriately discounted, is reported on the balance sheet as
“oil deposits.”
The costs of exploration incurred each year are deducted from the estimated reserves
discovered during the same period with the difference probably being reported as income.
The oil companies are concerned because the valuation issue is extremely tenuous. For
example, to properly value the reserves, the following must be estimated: (1) amount of the
reserves, (2) future production costs, (3) periods of expected disposal, (4) discount rate, and
(5) the selling price.
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HW Chap 11 Day 2
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 11-9
Inventory .......................................................................... 73,500
Coal Mine.................................................................
73,500
$400,000 + $100,000 + $80,000 – $160,000
= $105 per ton
4,000
700 X $105 = $73,500
SOLUTIONS TO EXERCISES
EXERCISE 11-21 (15–20 minutes)
(a)
$1,300 – $300 = $1,000 per acre for timber
$1,000 X 7,000 acres
X 880,000 bd. ft. =
8,000 bd. ft. X 7,000 acres
$7,000,000
X 880,000 bd. ft. = $110,000.
56,000,000 bd. ft.
$84,000
(b)
X 880,000 bd. ft. = $1,320.
56,000,000 bd. ft.
(c)
Jonas should capitalize the cost of $70,000 ($20 X 3,500 trees)
and adjust the depletion the next time the timber is harvested.
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