Question

(Depletion Computations—Oil) Diderot Drilling Company has leased property on which oil has been discovered. Wells on this property produced 18,000 barrels of oil during the past year that sold at an average sales price of \(55 per barrel. Total oil resources of this property are estimated to be 250,000 barrels.

The lease provided for an outright payment of \)500,000 to the lessor (owner) before drilling could be commenced and an annual rental of \(31,500. A premium of 5% of the sales price of every barrel of oil removed is to be paid annually to the lessor. In addition, Diderot (lessee) is to clean up all the waste and debris from drilling and to bear the costs of reconditioning the land for farming when the wells are abandoned. The estimated fair value, at the time of the lease, of this clean-up and reconditioning is \)30,000.

Instructions

From the provisions of the lease agreement, you are to compute the cost per barrel for the past year, exclusive of operating costs, to Diderot Drilling Company. (Round to the nearest cent.)

Short answer

The total cost per barrel is $6.62.

Step-by-step solution

Meaning of Depletion

Depletion measures the amount of natural resources that have been tapped over time. Accounting and tax reporting could be aided by depletion, much like devaluation. The most noticeable impact of depletion is on mining, lumber, petroleum, and the exploitation and utilization of common assets.

Computing the cost per barrel for the past year.

Working notes:

Computation of amount of initial payments

Computation of Rental amount

Computing amount of premium