(Full costing versus successful efforts, LO 3, 4, 9) Droxford Exploration Ltd.

(Droxford) and Bartibog Inc. (Bartibog) are oil exploration and development companies. In 2003 both companies did extensive exploration in Alberta. Each company drilled 12 wells and each found gas in four of the wells. The cost of exploring for the oil and drilling the wells was $1,500,000 per well. During 2005 each successful well produced $1,500,000 in revenue.

Both companies paid royalties to the Alberta government equal to 25% of the revenues from oil sales. In addition, for both companies the cost of producing the oil was $226,000 per well, general and administrative costs totalled $420,000, and interest costs were $305,000. Income taxes were $72,000. Geologists estimate that in 2003, 15% of the oil reserves in the wells was extracted and sold. The only difference between the two companies is that Droxford uses the successful efforts method for accounting for oil exploration costs and Bartibog uses full costing.

Required:

a. Prepare income statements for 2003 for Droxford and Bartibog. Assume that both companies use the unit-of-production method to amortize exploration costs.

b. Prepare the journal entry required by each company to record the cost of exploring for oil. Assume that all expenditures were paid in cash.

c. Suppose that total assets before accounting for oil exploration costs was

$42,000,000 for both companies. How would the balance sheets of the two companies differ?

d. Calculate the return on assets and profit margin for the two companies. Explain the differences between the two companies.

e. What difference does it make which method of accounting for exploration a company uses? Why do you think Droxford and Bartibog would choose one over the other? Explain fully. Remember that both methods are allowed by GAAP.