Depletion Expense What Is It, Formula, How To Calculate, Types

A single line providing the dollar amount of charges for the accounting period appears on the income statement. Depletion method of depreciation is mostly used by the companies that have assets that are natural resources like oil, gas, coal, mines, quarries or other wasting assets. Depletion is the process by which natural resources lose their benefits as the resources are removed. It follows the same process used in the units of production method of depreciation.

Composition of the Depletion Base

Excavating natural resources is a costly venture, and helping your clients save money and mitigate their tax liability is important. Clients in the mining, timber, and oil and gas industries must invest a lot of time, money, and resources to extract natural resources from the earth and transform them into useful products for consumers. This means that the unit depletion charge will increase to $1.61 ($450,000 remaining depletion base / 280,000 barrels).

Partial-Year Depreciation

Its proponents believe that the only relevant measure for a project is the cost directly related to it and that companies should report any remaining costs as period charges. This problem is the same as accounting for changes in estimates for the useful lives of plants and equipment. They do so because they have new information or more sophisticated production processes available. For example, MaClede Co. acquired the right to use 1,000 acres of land in Alaska to mine for gold. The lease cost is $50,000, and the related exploration costs on the property are $00.000.

• Estimating the future selling price, appropriate discount rate and future extraction and delivery costs of reserves that are years away from realization can be a formidable task.
• However, for oil and gas wells, mines, other natural deposits (including geothermal deposits), and mineral property, companies generally use the method that gives them the larger deduction.
• Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction.
• He also estimates that he will make 20,000 clothing items in year one and 30,000 clothing items in year two.

Accounting for Depreciation

If all of the resource is sold, we expense all of the depletion and removal costs. Cost depletion is typically part of the « DD&A » (depletion, depreciation, and amortization) line of a natural resource company’s income statement. Depletion is similar to depreciation, which is used to allocate the cost of tangible assets like factories and equipment over their useful lives. Depletion is used for natural resources, which can include minerals, ore, oil, gas, and timber. In particular, a company that extracts resources will use depletion to account for the use of these assets. Depreciation expense is a common operating expense that appears on an income statement.

But as with most corporate accounting issues, it’s essential to get advice from a trained professional, preferably someone who deals with depletion issues on a regular basis. Depletion also lowers the cost value of an asset incrementally through scheduled charges to income. Where it differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or the aging life of intangibles. E.g., cane crushing equipment in a sugar firm would be eligible for depreciation from the time of its use since there would be continuous wear and tear on the machine. However, in an oil company, the resources will have a depletion amount calculated during usage.

To determine the total cost of the resource available, we combine this depletion cost with other extraction, mining, or removal costs. 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.

For example, if $10 million of oil is extracted and the fixed percentage is 15%, $1.5 million of capitalized costs to extract the natural resource are depleted. The depletion rate per unit of a natural resource or asset depends upon the total number of units expected to be extracted. This is calculated by dividing the depletion base which method should be used to calculate depletion for a natural resource company? less salvage value (if any) by the number of units expected to be extracted. There are a number of different methods that can be used to account for depletion. The most common method is the straight-line Depreciation method, which allocates the depletion expense evenly over the estimated economic life of the natural resource.

Assets are recorded on the balance sheet at cost, meaning that all costs to purchase the asset and to prepare the asset for operation should be included. Costs outside of the purchase price may include shipping, taxes, installation, and modifications to the asset. Chevron Corp. (CVX) reported $19.4 billion in DD&A expense in 2018, more or less in line with the $19.3 billion it recorded in the prior year. In its footnotes, the energy giant revealed that the slight DD&A expense increase was due to higher production levels for certain oil and gas producing fields. Depreciation applies to expenses incurred for the purchase of assets with useful lives greater than one year. A percentage of the purchase price is deducted over the course of the asset’s useful life.