Q39PGB_1 - Horngren'S Financial And Managerial Accounting

Question

Donahue Oil Incorporated has an account titled Oil and Gas Properties. Donahue paid \(6,400,000 for oil reserves holding an estimated 400,000 barrels of oil. Assumethe company paid \)510,000 for additional geological tests of the property and$470,000 to prepare for drilling. During the first year, Donahue removed and sold75,000 barrels of oil. Record all of Donahue’s transactions, including depletion for thefirst year.

Step-by-Step Solution

Answer

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

Step 1: Meaning of Depletion

Allocating the cost of extracting natural resources over their usage is termed depletion.

Step2: Showing journal entries

Date	Particulars	Debit($)	Credit ($)
Jan 1	Oil and Gas reserve (refer working note 1)	7,380,000
	Cash		7,380,000
	(To record purchase     of oil and gas reserve )
Dec 31	Depletion expense - Oil & Gas reserve	1,383,750
	Accumulated depletion- Oil & Gas reserve		1,383,750
	(To record depletion expense)

Working note:

1. Calculation of purchase price of reserve

$\begin{array}{c}Aquisitioncostofreserve=Purchaseprice+Geologicaltest+Drillingexpense\\ =\$6,400,000+\$510,000+\$470,000\\ =\$7,380,000\end{array}$

       2. Calculation of Depletion Expense

$\begin{array}{c}Depletionperbarrel=\frac{Cost-ResidualValue}{EstimatedOilReserve}\\ =\frac{\$7,380,000-\$0}{400,000}\\ =\$18.45\end{array}$

$\begin{array}{c}DepletionExpense=Depletionperbarrel\times No.ofbarrelsextracted\\ =\$18.45\times 75,000\\ =\$1,383,750\end{array}$