On June 1, 2009, Ignacio Mining entered into an agreement with the state of Nevada to obtain the rights to operate a mineral mine in Nevada for $15.8 million. Additional costs and purchases included the following:
Development costs in preparing the mine $5,900,000
Mining machinery $212,300
Construction of various structures on site $97,520
After the minerals are removed from the mine, the machinery will be sold for an estimated residual value of $13,800. The structures will be torn down.
Geologists estimate that 1,000,000 tons of ore can be extracted from the mine. After the ore is removed the land will revert back to the state of Nevada.
The contract with the state requires Ignacio to restore the land to its original condition after mining operations are completed in approximately five years. Management has provided the following possible outflows for the restoration costs:
Cash Outflow Probability
$800,000 35%
$990,000 40%
$1,000,000 25%
Ignacio’s credit-adjusted risk-free interest rate is 7 %. During 2009, Ignacio extracted 185,000 tons of ore from the mine.
Required:
1. Determine the amount at which Ignacio will record the mine.
2. Calculate the depletion of the mine and the depreciation of the mining facilities and equipment for 2009, assuming that Ignacio uses the units-of-production method for both depreciation and depletion. Round depletion and depreciation rates to four decimals.
3. Are depletion of the mine and depreciation of the mining facilities and equipment reported as separate expenses in the income statement? Discuss the accounting treatment of these items in the income statement and balance sheet.
4. During 2010, Ignacio changed its estimate of the total amount of ore originally in the mine from 1,000,000 to 1,250,000 tons. Briefly describe the accounting treatment the company will employ to account for the change and calculate the depletion of the mine and depreciation of the mining facilities and equipment for 2010 assuming Ignacio extracted 175,000 tons of ore in 2010.