Mayfair Mining Company Total Depletable Capitalized Co

Mayfair Mining Company Had A Total Depletable Capitalized Cost Of 656

Mayfair Mining Company had a total depletable capitalized cost of $656,000 for a mine acquired in early 2013. It was estimated that the mine contained 820,000 tons of recoverable ore when production began. During 2013, 20,500 tons were mined, and 41,000 tons were mined in 2014.

This paper will analyze the calculation of depletion expenses for 2013 and 2014 for financial accounting purposes, including journal entries involved in recording depletion. It will also explore the tax implications of depletion, comparing cost and percentage depletion methods, and discussing the differences between tax rules and accounting principles in the depletion of mineral costs.

Paper For Above instruction

Introduction

Mining operations require precise accounting for the depletion of mineral assets, which directly affects both financial reporting and tax liabilities. Depletion is the systematic allocation of the cost of natural resources over the period they are mined and sold. Accurate calculation and recording of depletion ensure compliance with accounting standards and tax regulations, and understanding the differences between financial and tax depletion methods is essential for proper financial management.

Financial Accounting Depletion Calculation for 2013 and 2014

The initial capitalized cost of the mine was $656,000, with an estimated 820,000 tons of recoverable ore. The depletion rate per ton, based on the units-of-activity method, is calculated as:

Depletion rate per ton = Capitalized cost / Estimated recoverable ore

= $656,000 / 820,000 tons ≈ $0.80 per ton

In 2013, 20,500 tons were mined, resulting in a depletion expense of:

Depletion expense 2013 = 20,500 tons × $0.80 = $16,400

For journal entries, the depletion expense would be debited, and the accumulated depletion (a contra asset account) credited:

Debit: Depletion Expense $16,400
Credit: Accumulated Depletion $16,400

In 2014, 41,000 tons were mined, and the depletion expense would be:

Depletion expense 2014 = 41,000 tons × $0.80 = $32,800

The journal entry for 2014 is similar:

Debit: Depletion Expense $32,800
Credit: Accumulated Depletion $32,800

Tax Depletion Calculations and Analysis

(a) Percentage Depletion in 2013

The percentage depletion method allows deducting a percentage of gross income from the mine. For 2013, the gross sales were $2,050,000, and the allowable percentage depletion rate for the ore is 8%:

Percentage depletion = 8% × $2,050,000 = $164,000

However, this is limited to the net income from the property. The net income is calculated as gross income minus operating expenses:

Net income = $2,050,000 - $500,000 = $1,550,000

Since the percentage depletion cannot exceed net income, the allowable percentage depletion for 2013 is $164,000, which is less than the net income, so the full amount is deductible.

(b) Cost Depletion for Tax Purposes in 2013

The cost depletion is based on the number of units sold relative to the total estimated recoverable units. The total capitalized cost for tax purposes is assumed to be the same as for financial accounting ($656,000). The depletion per ton remains at $0.80.

Cost depletion for the 20,500 tons sold is:

Cost depletion = 20,500 tons × $0.80 = $16,400

This matches the financial accounting depletion, assuming identical capitalized costs.

(c) Depletion Deduction in 2014 with Prior Percentage Depletion

Any depletion taken in prior years reduces the remaining basis for cost depletion calculations. Assuming the company deducts the full percentage depletion of $164,000 in 2013, the remaining basis for cost depletion becomes:

Remaining basis = Initial cost - depletion taken

$656,000 - $164,000 = $492,000

In 2014, with 41,000 tons mined, the cost depletion based on the remaining basis is:

64,500 tons (assuming total recovery of ore) / 820,000 total estimated tons = 0.0787

Thus, the cost depletion in 2014 is:

Cost depletion = 41,000 tons × ($492,000 / 820,000) ≈ $24,600

This reflects an adjustment based on prior depletion deductions.

Analysis of Tax Rules vs. Accounting Principles in Mineral Depletion

The deviation of income tax rules from basic accounting principles relates primarily to the need for simplicity, predictability, and encouragement of resource development. Tax authorities often permit accelerated depletion methods, such as percentage depletion, which can allow companies to recover costs more rapidly than would be permitted under generally accepted accounting principles (GAAP). This disparity aims to promote exploration and development by providing immediate tax benefits, although it may distort income figures compared to financial statements. Additionally, tax regulations limit depletion deductions to net income from the property, ensuring the taxpayer does not deduct more than actual economic profit, aligning tax policy with economic reality, but diverging from the more systematic and consistent approach of GAAP.

Conclusion

The calculation of depletion expense is essential for accurately representing the consumption of natural resources in financial statements and for tax reporting. Financial accounting uses the units-of-activity method based on recoverable units, while tax regulations permit the use of percentage depletion, which can be more advantageous but also less aligned with actual physical resource depletion. Understanding these distinctions helps in effective financial planning and ensures compliance with regulatory requirements.

References

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