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Cost of Natural Resource

Jackpot Mining Company operates a copper mine in central Montana. The company paid $ 1,000,000 in 2011 for the mining site and spent an additional $ 600,000 to prepare the mine for extraction of the copper. After the copper is extracted in approximately four years, the company is required to restore the land to its original condition, including repaving of roads and replacing a greenbelt. The company has provided the following three cash flow possibilities for the restoration costs: Cash Outflow Probability 1 $ 300,000 25% 2 400,000 40% 3 600,000 35% To aid extraction, Jackpot purchased some new equipment on July 1, 2011, for $ 120,000. After the copper is removed from this mine, the equipment will be sold for an estimated residual amount of $ 20,000. There will be no residual value for the copper mine. The credit- adjusted risk- free rate of interest is 10%. The company expects to extract 10 million pounds of copper from the mine. Actual production was 1.6 million pounds in 2011 and 3 million pounds in 2012. Required: 1. Compute depletion and depreciation on the mine and mining equipment for 2011 and 2012. The units- of-production method is used to calculate depreciation. 2. Discuss the accounting treatment of the depletion and depreciation on the mine and mining equipment.

Solution Preview

The mine costs, including the cost to restore the site, are depletion based on how much is extracted. So, the useful life is in terms of pounds, not years. The mining equipment, however, is depreciated just like any other operating asset using straight line depreciation. The mine is different ...

Solution Summary

I have shown you how to estimate the restoration costs and discount it back to the present to add it to the cost of the mine site. Formulas are shown and computations are in the cells (click to see). A discussion of how depletion and depreciation differ was included as well as a short note on how to handle the restoration liability.