Q39PGB - Horngren'S Financial And Managerial Accounting

Question

Donahue Oil Incorporated has an account titled Oil and Gas Properties. Donahue paid \(6,400,000 for oil reserves holding an estimated 400,000 barrels of oil. Assume the company paid \)510,000 for additional geological tests of the property and $470,000 to prepare for drilling. During the first year, Donahue removed and sold 75,000 barrels of oil. Record all of Donahue’s transactions, including depletion for the first year.

Step-by-Step Solution

Answer

Depletion expense for the year: $1,383,750

Step 1: Journal entry for the acquisition

Date	Particular	Debit	Credit
Jan 1.	Oil and Gas reserve	$ 7,380,000
	To Cash		$ 7,380,000
	Being oil and gas reserve purchased with additional expense

Working:

$\begin{array}{rcl}\mathrm{Acquisition} \mathrm{cost} \mathrm{of} \mathrm{reserve}& =& \mathrm{Purchase} \mathrm{price}+\mathrm{Geological} \mathrm{test}+\mathrm{Drilling} \mathrm{expense}\\ & =& \$6,400,000+\$510,000+\$470,000\\ & =& \$7,380,000\end{array}$

Step 2: Journal entry for depreciation

Date	Particular	Debit	Credit
Dec 31.	Depletion expense - Oil and Gas reserve	$ 1,383,750
	To Accumulated depletion – Oil and Gas reserve		$ 1,383,750
	Being depletion charged for extraction

Working:

$\begin{array}{rcl}\mathrm{Depletion} \mathrm{per} \mathrm{barrel}& =& \frac{\mathrm{Cost}-\mathrm{Residual} \mathrm{Value}}{\mathrm{Estimated} \mathrm{oil} \mathrm{reserve}}\\ & =& \frac{\$7,380,000-\$0}{400,000}\\ & =& \$18.45\\ & & \\ \mathrm{Depletion} \mathrm{expense}& =& \mathrm{Depletion} \mathrm{per} \mathrm{barrel}\times \mathrm{No}. \mathrm{of} \mathrm{barrels} \mathrm{extracted}\\ & =& \$18.45\times 75,000\\ & =& \$1,383,750\end{array}$