Perez Company acquired a mineral property and drilled an oil well in 2016. Capitalized costs subject to depletion totaled $800,000. When the well began producing in late 2016, it was estimated that one million barrels of oil could ultimately be produced from the property. In 2016, 5,000 barrels were produced and sold for $180,000. Operating costs for the property were $160,800. Sixty thousand barrels were produced and sold for $2,600,000 in 2017 and operating costs that year were $330,000.
INSTRUCTIONS
1. Compute the depletion expense in 2016 and 2017 for financial accounting purposes. What accounts will be debited and credited to record the depletion?
2. Assume that capitalized costs and operating expenses were the same for financial accounting and tax purposes. The taxpayer may deduct either cost depletion or percentage depletion. The percentage depletion for oil and gas production is 15 percent of gross income from the property, but limited to 100 percent of net income from the property. Assume that all of the oil produced is eligible for percentage depletion.
a. What would be the amount of cost depletion allowable for tax purposes in 2016?
b. What will be the amount of depletion that the company could deduct on its tax return in 2016?
c. What amount of cost depletion could the company deduct on its tax return in 2017?
d. What would be the amount, if any, of percentage depletion deductible in 2017?
e. Suppose that in the first four years of the property's life, the company deducted depletion totaling $798,800 on the tax returns. No additional depletable costs were capitalized. In the fifth year of the property's life, proceeds of $4,800,000 were received from the oil produced, and operating expenses of $900,000 were incurred. What amount, if any, of percentage depletion may be deducted on the company's tax return in that year?
Analyze: Would the company be entitled to percentage depletion in the sixth and future years in which there was gross income that exceeded the operating expenses?