Depletion: Definition, 4 Affecting Factors, and Depletion Methods

Total costs related to the mine before the first ounce of gold is extracted are, therefore, $1,000,000. MacLeod estimates that the mine will provide approximately 100,000 ounces of gold. The illustration below shows the computation of the depletion cost per unit (depletion rate). Normally, companies compute depletion (often referred to as cost depletion) on a units-of-production method (an activity approach).

Depreciation, Depletion, and Amortization (DD&A): Examples

Different appraisals can result in different determinations of “fair value.” Thus, the Financial Accounting Standards Board (FASB) elected to continue with the current method of carrying assets at their depreciated historical cost. The thought process behind the adjustments to fair value under IFRS is that fair value more accurately represents true value. Even if the fair value reported which method should be used to calculate depletion for a natural resource company? is not known with certainty, reporting the class of assets at a reasonable representation of fair value enhances decision-making by users of the financial statements. Both US GAAP and International Financial Reporting Standards (IFRS) account for long-term assets (tangible and intangible) by recording the asset at the cost necessary to make the asset ready for its intended use.

• Suppose your company owns a single building that you bought for $1,000,000.
• In the income statement, the depletion cost is part of the cost of goods sold.
• Next, because assets are typically more efficient and “used” more heavily early in their life span, the double-declining method takes usage into account by doubling the straight-line percentage.
• Depletion is the process by which natural resources lose their benefits as they are removed.

AccountingTools

In that case, it may gradually distribute to stockholders its capital investments by paying liquidating dividends, which are dividends greater than the amount of accumulated net income. Tangible equipment costs include all the transportation and other heavy equipment needed to extract the resource and prepare it for the market. Assume that on January 1, 2019, Kenzie Company bought a printing press for $54,000.

Formula

Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License . This book uses the Creative Commons Attribution-NonCommercial-ShareAlike License and you must attribute OpenStax. This book may not be used in the training of large language models or otherwise be ingested into large language models or generative AI offerings without OpenStax’s permission. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.

Natural resources

Cost depletion is one of two accounting methods used to allocate the costs of extracting natural resources, such as timber, minerals, and oil, and to record those costs as operating expenses to reduce pretax income. The yearly depletion cost is based on the units extracted or used for a given time period. Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction.

Kenzie pays shipping costs of $1,500 and setup costs of $2,500, assumes a useful life of five years or 960,000 pages. Based on experience, Kenzie Company anticipates a salvage value of $10,000. When researching companies, the financial statement is a great place to start.

For example, Atlantic Richfield Co., at one time, reported net producing property of $2.6 billion. The major accounting problem is to distinguish between dividends that are a return of capital and those that are not.

One unique feature of the double-declining-balance method is that in the first year, the estimated salvage value is not subtracted from the total asset cost before calculating the first year’s depreciation expense. However, depreciation expense is not permitted to take the book value below the estimated salvage value, as demonstrated in the following text. In this section, we concentrate on the major characteristics of determining capitalized costs and some of the options for allocating these costs on an annual basis using the depreciation process. In the determination of capitalized costs, we do not consider just the initial cost of the asset; instead, we determine all of the costs necessary to place the asset into service. This method is named as ‘depletion method’ because the reduction of a natural resource or asset is known as depletion of that resource or asset and thus is used to depreciate assets that are natural resources.

The units-of-production depreciation method bases depreciation on the actual usage of the asset, which is more appropriate when an asset’s life is a function of usage instead of time. For example, this method could account for depreciation of a printing press for which the depreciable base is $48,000 (as in the straight-line method), but now the number of pages the press prints is important. From an accounting standpoint, depletion ensures that the value of assets listed on a balance sheet and expenses on an income statement are recorded accurately and in a timely fashion.

Thus, RRA is a fair value approach, in contrast to full-costing and successful efforts, which are historical cost approaches. Using RRA would make a substantial difference in oil companies’ balance sheets and income statements. A major controversy relates to the accounting for exploration costs in the oil and gas industry. Conceptually, the question is whether unsuccessful ventures are a cost to those that are successful. A company often owns a property from which it intends to extract natural resources as its only major asset.

Analysts and investors in the energy sector should be aware of this expense and how it relates to cash flow and capital expenditure. We follow strict ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources. The usefulness of resources to a firm is generally directly proportional to the amount extracted (or otherwise removed). Cost depletion is more often used by companies and typically provides the most accurate calculations. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. Currently, companies can use either the full-cost approach or the successful-efforts approach.