Exercise 11-20 Shamrock Drilling Company has leased property on which oil has be

Question

Exercise 11-20

Shamrock Drilling Company has leased property on which oil has been discovered. Wells on this property produced 18,310 barrels of oil during the past year that sold at an average sales price of $62 per barrel. Total oil resources of this property are estimated to be 271,500 barrels.

The lease provided for an outright payment of $560,000 to the lessor (owner) before drilling could be commenced and an annual rental of $35,280. A premium of 5% of the sales price of every barrel of oil removed is to be paid annually to the lessor. In addition, Shamrock (lessee) is to clean up all the waste and debris from drilling and to bear the costs of reconditioning the land for farming when the wells are abandoned. The estimated fair value, at the time of the lease, of this clean-up and reconditioning is $33,600.

From the provisions of the lease agreement, compute the cost per barrel for the past year, exclusive of operating costs, to Shamrock Drilling Company. (Round answer to 2 decimal places, e.g. 4.89.)

Explanation / Answer

Calculation of total cost per barrel :-

Initial payment [$560,000 / 271,500 barrels] = $2.06 per barrel

Add: Rent cost [$35,280 / 18,310 barrels  ] = $1.93 per barrel

Add: premium of 5% of the sales price [5% * $62 per barrel] = $3.1 per barrel

Add: clean-up and reconditioning [$33,600 /271,500 barrels ] = $0.12 per barrel

             Total cost per barrel = $7.21 per barrel

  Note:- Initial Outright payment of $560,000 to the lessor (owner) and estimated fair value, at the time of the lease, clean-up and reconditioning of $33,600, will be on the basis of 271,500 barrels.

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