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

(Forillon) and Gullbridge Gas Inc. (Gullbridge) are natural gas exploration and development companies. In 2005 both companies did extensive exploration in northern Alberta. Each company drilled seven wells and each found gas in three of the wells. The cost of exploring for the gas and drilling the wells was $2,000,000 per well. During 2005 each successful well produced $945,000 in gas revenue.

Both companies paid royalties to the Alberta government equal to 25% of the revenues from gas sales. In addition, for both companies the cost of producing the natural gas was $56,000 per well, general and administrative costs totalled $220,000, and interest costs were $105,000. Income taxes were $72,000. Geologists estimate that in 2005, 10% of the gas reserves in the wells was extracted and sold. The only difference between the two companies is that Forillon uses the successful efforts method for accounting for gas exploration costs and Gullbridge uses full costing.

Required:

a. Prepare income statements for 2005 for Forillon and Gullbridge. 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 natural gas. Assume that all expenditures were paid in cash.

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

$27,000,000 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 difference between the two companies.

e. Which company is more successful? Explain. Which company would you invest in if you could only invest in one of them? Explain.