our client, Hazelton Mining, recently entered into an agreement to obtain the rights to operate a coal mine in West Virginia for $15 million. Hazelton incurred development costs of $6 million in preparing the mine for extraction, which began on July 1, 2021. The contract requires Hazelton to restore the land and surrounding area to its original condition after extraction is complete in three years. The company controller, Alice Cushing, is not sure how to account for the restoration costs and has asked your advice. Alice is aware of an accounting standard address
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
Your client, Hazelton Mining, recently entered into an agreement to obtain the rights to operate a coal mine in West Virginia for $15 million. Hazelton incurred development costs of $6 million in preparing the mine for extraction, which began on July 1, 2021. The contract requires Hazelton to restore the land and surrounding area to its original condition after extraction is complete in three years.
The company controller, Alice Cushing, is not sure how to account for the restoration costs and has asked your advice. Alice is aware of an accounting standard addressing this issue, but is not sure of its provisions. She has narrowed down the possible cash outflows for the restoration costs to four possibilities.
| Probability | |||||
| $ | 3 | million | 20 | % | |
| 4 | million | 30 | % | ||
| 5 | million | 25 | % | ||
| 6 | million | 25 | % | ||
Alice also informs you that the company’s credit-adjusted risk-free interest rate is 9%. Before responding to Alice, you need to research the issue.
Research Case 10–2 (Static) Part 5
5. Explain to Alice how Hazelton would account for the restoration if the restoration costs differed from the recorded liability in three years. By way of explanation, prepare the
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