Question

(Depletion, Timber, and Unusual Loss) Conan O’Brien Logging and Lumber Company owns 3,000 acres of timberland on the north side of Mount Leno, which was purchased in 2005 at a cost of \(550 per acre. In 2017, O’Brien began selectively logging this timber tract. In May 2017, Mount Leno erupted, burying the timberland of O’Brien under a foot of ash. All of the timber on the O’Brien tract was downed. In addition, the logging roads, built at a cost of \)150,000, were destroyed, as well as the logging equipment, with a net book value of \(300,000.

At the time of the eruption, O’Brien had logged 20% of the estimated 500,000 board feet of timber. Prior to the eruption, O’Brien estimated the land to have a value of \)200 per acre after the timber was harvested. O’Brien includes the logging roads in the depletion base.

O’Brien estimates it will take 3 years to salvage the downed timber at a cost of \(700,000. The timber can be sold for pulp wood at an estimated price of \)3 per board foot. The value of the land is unknown, but must be considered nominal due to future uncertainties.

Instructions

1. Determine the depletion cost per board foot for the timber harvested prior to the eruption of Mount Leno.
2. Prepare the journal entry to record the depletion prior to the eruption.
3. If this tract represents approximately half of the timber holdings of O’Brien, determine the amount of the unusual loss due to the eruption of Mount Leno for the year ended December 31, 2017.

Short answer

1. Depletion cost per board foot = $2.40
2. Depletion = $240,000
3. Loss of timber = $840,000

Step-by-step solution

Step-by-Step SolutionStep 1: Meaning of Depletion

Theloss of natural resources as a result of access to them on a regular basis is called depletion.Hence, a company uses them when any kind of registered asset is involved, such as oil, coal, or gravel deposits.

(a) Determining depletion cost

Original cost $(\mathrm{\$}550\times 3,000)$	$1,650,000
Deduct the residual value of land $(\mathrm{\$}200\times 3,000)$	600,000
	1,050,000
Cost of logging road	150,000
	$1,200,000

Calculating depreciation per board foot

$$\begin{gathered} \text{Depreciation}=\frac{\text{Depletion\hspace{0.17em}cost}}{\text{Estimated\hspace{0.17em}board\hspace{0.17em}feet\hspace{0.17em}timber}} \\ =\frac{\mathrm{\$}1,200,000}{500,000} \\ =\mathrm{\$}2.40 \end{gathered}$$

(b) Preparing journal entry

Date	Particular	Debit ($)	Credit ($)
	Inventory	240,000
	Timber		240,000

Calculating depletion value for 2017

$$\begin{gathered} \text{Depletion}=(\text{Logged\hspace{0.17em}rate}\times \text{Estimated\hspace{0.17em}board\hspace{0.17em}feet})\times \text{Depletion\hspace{0.17em}per\hspace{0.17em}board\hspace{0.17em}foot} \\ =(20\mathrm{\%}\times 500,000)\times \mathrm{\$}2.40 \\ =\mathrm{\$}240,000 \end{gathered}$$

(c) Calculating the amount of unusual loss

Loss of timber $ 840,000
Cost of salvaging timber 700,000
Less: Recovery $(\mathrm{\$}3\times 400,000\text{\hspace{0.17em}bd.\hspace{0.17em}ft}.)$ 1,200,000	$ 340,000
Loss of land value	600,000
Loss of logging roads $[\mathrm{\$}150,000-(20\mathrm{\%}\times \mathrm{\$}150,000)]$	120,000
Logging equipment	300,000
Unusual loss due to the eruption of Mt. Leno	$1,360,000

Working notes:

Calculating the value of loss of timber

$$\begin{gathered} \text{Loss\hspace{0.17em}of\hspace{0.17em}timber}=\text{Original\hspace{0.17em}cost}-\text{Residual\hspace{0.17em}value}-(\text{Cost}\times \text{Logged\hspace{0.17em}rate}) \\ =\mathrm{\$}1,650,000-\mathrm{\$}600,000-(\mathrm{\$}1,050,000\times 20\mathrm{\%}) \\ =\mathrm{\$}1,050,000-\mathrm{\$}210,000 \\ =\mathrm{\$}840,000 \end{gathered}$$