Lucky Strike Mine (LLC) purchased a silver deposit for $1,500,000. It estimated it would extract 500,000 ounces of silver from the deposit. Lucky Strike mined the silver and sold it, reporting gross receipts of $1.8 million, $2.5 million, and $2 million for Years 1 through 3, respectively. During Years 1 through 3, Lucky Strike reported net income (loss) from the silver deposit activity in the amount of ($100,000), $400,000, and $100,000, respectively. In Years 1 through 3, Lucky Strike extracted 300,000 ounces of silver as follows: Ounces extracted per year Year 1 Year 2 Year 3 50,000 150,000 100,000 What is Lucky Strike's depletion deduction for Year 2 if the applicable percentage depletion for silver is 15 percent? Multiple Choice $200,000 None of the choices are correct. $450,000 $400,000 $375,000
To calculate the depletion deduction for Lucky Strike Mine, we need to consider both cost depletion and percentage depletion and then use the method that results in the larger deduction. Cost Depletion: Cost depletion is calculated based on the cost of the resource divided by the total estimated recoverable units, which gives a per-unit depletion rate. This rate is then multiplied by the number of units sold during the year. Cost of the deposit: $1,500,000 Estimated recoverable units: 500,000 ounces Cost per ounce: $1,500,000 / 500,000 ounces = $3 per ounce Ounces extracted in Year 2: 150,000 ounces Cost depletion for Year 2: 150,000 ounces * $3 per ounce = $450,000 Percentage Depletion: Percentage depletion is calculated by multiplying the gross income from the mining process by the depletion percentage rate applicable to the resource. Applicable percentage depletion for silver: 15% Gross receipts in Year 2: $2,500,000 Percentage depletion for Year 2: $2,500,000 * 15% = $375,000 Lucky Strike should use the method that gives the larger deduction. In this case, cost depletion of $450,000 is larger than percentage depletion of $375,000. Therefore, the correct depletion deduction for Year 2 is: $450,000 The correct answer is: $450,000
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