What is depletion in accounting? California Learning Resource Network

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

How Ram Simplified His Study Process and Passed the CPA Exams

We can assign this total cost to either the cost of natural resources sold or the inventory of the natural resource still on hand. Thus, we could expense all, some, or none of the depletion and removal costs recognized in an accounting period, depending on the portion sold. The yearly depletion cost is based on the units extracted or used for a given time period. Plant assets and natural resources are tangible assets used by a company to produce revenues. On the income statement, depreciation expense is recorded for plant assets and depletion expense is recorded for natural resources.

Advance Your Accounting and Bookkeeping Career

Hence, these methods help the company to record the asset / resource’s value as it reduces due to the usage, and hence, help to understand its value at a given time. Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction. Enterprises with an economic interest in mineral property or standing timber may recognize depletion expenses against those assets as they are used.

Related AccountingTools Course

However, you may not know how an asset such as land with minerals is handled in accounting. Instead, in the absence of natural resources that are to be extracted (see below), land is considered to have an unlimited life span. By crediting the Accumulated Depletion account instead of the asset account, we continue to report the original cost of the entire natural resource on the financial statements. To determine the total cost of the resource available, we combine this depletion cost with other extraction, mining, or removal costs.

It represents the total amount of a natural resource’s original cost that has been used up or depleted through the extraction or consumption process. Accumulated depletion is recorded on a company’s balance sheet as a contra asset account, which reduces the value of the natural resource asset. Depletion can be calculated on a cost or percentage basis, and businesses generally must use whichever provides the larger deduction for tax purposes. Nearly all fixed assets have a useful life, after which they no longer contribute to the operations of a company or they stop generating revenue.

Percentage Depletion Method

As natural resources are extracted, they are counted and taken out from the property’s basis. Depletion expense is typically calculated using either the Unit-of-Production method or the percentage depletion method. The Unit-of-Production method divides the cost of the resource by the total estimated units of production and multiplies it by the units extracted during the period.

• Accumulated depletion provides a systematic allocation of the cost of a depletable asset over its useful life.
• Whereas in the oil company, its resource will have depletion amount being calculated as it is used.
• Accumulated depletion is an accounting concept used to allocate the cost of natural resources as they are extracted or consumed over time.
• Companies use this to record the diminishing value of their assets as they are used in the business from the time of purchase of such assets.
• Unlike depreciation, cost depletion is based on usage and must be calculated every period.
• The company would then expense $1 per barrel of oil extracted against its income statement.

Accumulated depletion increases over time as more of the resource is extracted, reflecting the reduction in the resource’s value. Depletion is the exhaustion that results from the physical removal of a part of a natural resource. In each accounting period, the depletion recognized is an estimate of the cost of the natural resource that was removed from its natural setting during the period. To record depletion, debit a Depletion account and credit an Accumulated Depletion account, which is a contra account to the natural resource asset account. Cost depletion is calculated by taking the property’s basis, total recoverable reserves and number of units sold into account.

• Explanations may also be supplied in the footnotes, particularly if there is a large swing in the depreciation, depletion, and amortization (DD&A) charge from one period to the next.
• The percentage depletion method requires a lot of estimates and is, therefore, not a heavily relied upon or accepted method of depletion.
• E.g. computer equipment in a company would be considered for depreciation from the point of time of it in use.
• Cost depletion is typically part of the “DD&A” (depletion, depreciation, and amortization) line of a natural resource company’s income statement.
• However, you may not know how an asset such as land with minerals is handled in accounting.
• Depreciation, depletion, and amortization (DD&A) is an accounting technique that enables companies to gradually expense various different resources of economic value over time in order to match costs to revenues.

A single line providing the dollar amount of charges for the accounting period appears on the income statement. Depletion for accounting and financial reporting purposes is meant to assist in accurately identifying the value of the the accumulated depletion account is assets on the balance sheet and recording expenses in the appropriate time period on the income statement. Like depreciation and amortization, depletion is a non-cash expense that lowers the cost value of an asset incrementally through scheduled charges to income. Where depletion differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or aging life of intangibles.