Donahue oil company has an account titled oil and gas properties. donahue paid $6, 900,000 for oil reserves holding an estimated 1.000.000 barrels of oil. assume the company paid $570,000 for additional geological tests of the property and $410,000 to prepare for drilling. during the first year. donahue removed and sold 82.000 barrels of oil. record all of donahue's transactions, including depletion for the first year.

Here we have three transaction and we have to deal these in-accordance to International Accounting Standard 16 Property, Plant and Equipment. The standard says that the Purchases of the Non-current assets must be capitalized as Non-current assets. Furthermore, if their is an estimated life of the asset then it must be depreciated. Here the life of oil reserve can be estimated by the number of oil barrels which is 1,000,000 barrels. So it must be depreciated according to the number of barrels extracted from the oil reserve. According to the IAS 16, the geological surveys must be expensed out in the year in which this expense was incurred.

Explanation:

Now we will record the all the three transactions for the year as below:

Purchase of NCA:

Dr Oil Reserve  $6,900,000

Cr           Bank                      $6,900,000

Depletion of Asset:

Dr Depreciation Expense  $565,800

Cr          Accumulated Depreciation      $565,800

The depreciation is calculated as under:

The depreciation of the asset will be calculated according to fair method that represents the fair decrease in its value. In the case of oil reserve, depletion of the asset is not due to its life period it is depends upon the quantity of barrels extracted.

Now,

Depreciation = Asset Monetary Value * Barrels extracted / Total Barrels

Depreciation = $6,900,000* 82,000 barrels/ 1,000,000 total barrels

Depreciation Expense for the year= $565,800

Geological Tests:

The third transaction relates to geographical survey, which must not be capitalized and must be expensed out in the year in which it was incurred:

Dr   Geological tests $570,000

Cr           Bank                      $570,000

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