[noah.c]

With regards to the following question (and solution) I don’t understand the solution. My question on the solution is below:

A firm began a mineral exploitation venture during the current year by spending (1) $40 million for the mineral rights; (2) $100 million exploring for the minerals, one-fourth of which were successful; and (3) $60 million to develop the site. Management estimated that 20 million tons of ore would ultimately be removed from the property. Wages and other extraction costs for the current year amounted to $10 million. In total, 2 million tons of ore were removed from the deposit in the current year. The entire production for the period was sold. Compute cost of goods sold under the successful efforts method.

a) 30 million
b) 12.5 million
c) 10 million
d) 22.5 million

The answer is D) with the following explanation:
The depletion rate = [$40 + (.25)($100) + $60]/20 = $6.25/ton. Depletion = 2,000,000($6.25/ton) = $12,500,000. Because all the ore removed was sold, cost of goods sold includes the entire amount of depletion and the extraction costs. Cost of goods sold = $12,500,000 + $10,000,000 = $22,500,000. Note, that extraction costs is included in inventory (and therefore, cost of goods sold), but not in the deposit (and therefore, not in depletion).

Me again: I don’t understand where the 10,000,000 comes from in the calculation. If the total cost of exploration was 100 million should that be incuded in the total? Not 10% of it?!?

Thanks!

[Anonymous]

The $10MM used in the COGS calculation (12.5MM + 10MM) is the $10MM from wages and other extraction costs.
Not sure if you missed this part – “Wages and other extraction costs for the current year amounted to $10 million”

[Recked]

Exploring was 100mil, but only 25% successful, so only 25mil of the exploration is added to this asset.
40mil rights
+25mil exploration (successful portion)
+60mil site development
Total basis in site = 125mil
2tons / 20 tons = .1 or 10% depletion

125mil x 10% = 12.5mil depletion
plus 10mil for direct costs – wages and other extraction costs

12.5 + 10 = 22.5 mil as total COGS

[mad max]

First, solve for depletion rate.

Depletion basis = 40 + 100*.25 + 60 = $125
Expected return = 20 tons
Depletion rate = 125/20 = $6.25 (per ton)

Then, use extracted amount times the depletion rate

Depletion Rate * Amt Extracted = 6.25 * 2 = $12.5
Alternatively, solve by (Amount Extracted/Total Amount)*(Depletion Basis)=[(2/20)*125].

Lastly, add other extraction costs of $10

10 + 12.5 = $22.5

[noah.c]

Thanks. I almost just slapped myself in the face for missing that.
Clearly I'm tired of studying.

[Author]

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