Cost Depletion: Meaning, Formula, Example

Now, we use the $1.00 expense per unit as the basis of our total expense calculation. It would record depletion expense of $8,500 (8,500 trees https://accounting-services.net/how-to-develop-consistency-as-a-skill/ x $1 per unit) for the year. Cost depletion is more widely accepted since it’s easier to calculate and works less with estimations.

• The usefulness of resources to a firm is generally directly proportional to the amount extracted (or otherwise removed).
• This allocates expenses by assigning a fixed percentage value to gross revenue from the property during the tax year.
• Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.
• This method is often used when the recoverable units cannot be easily measured, such as in the case of timber.
• Therefore, if Company ABC generates $10 million in revenue, and the percentage depletion is 2%, then it can assume that $200,000 of that revenue is a result of resource depletion.
• All three terms are used in the oil and gas industry, where the term DD&A has arisen to refer to all three types of expense recognition.

Mineral property includes oil and gas wells, mines, and other natural resource deposits (including geothermal deposits). For that purpose, property is each separate interest businesses own in each mineral deposit in each separate tract or parcel of land. Businesses can treat two or more separate interests as one property or as separate properties. Depletion expense is a charge against profits for the use of natural resources.

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The concept differs from depreciation, where the calculation is based on a fixed usage period. With depletion, there is no fixed usage period; instead, the usage level could vary substantially from period to period. Cost Depletion Method
The cost-depletion method is the second approach to measuring depletion.

Keep reading to learn more, including how it works, some different methods, and how to calculate it. For related information, read about how to account for depletion and other non-cash charges. Explanations may also be supplied in the footnotes, depletion definition accounting particularly if there is a large swing in the depreciation, depletion, and amortization (DD&A) charge from one period to the next. The value of an asset decreases due to a number of reasons including wear and tear or obsolescence.

Depletion (accounting)

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. Other methods include the units-of-production method and the percent-of-revenue method. The calculation of depletion expense is to multiply the number of consumed units of the natural resources by the cost per unit. The cost per unit is derived by aggregating the total cost to purchase, explore for, and develop the natural resources, divided by the total number of units expected to be extracted. Depletion can only be used for natural resources, while depreciation is allowed for all tangible assets.

Price depletion is measured, taking into account the base of the land, gross recoverable reserves, and the number of units sold. The basis of the property is distributed among the total number of units which can be recovered. These are counted and taken out of the base of the property when natural resources are removed. Cost depletion is a method for allocating the cost of natural resource extraction to the units produced. The concept is used to determine the amount of extraction cost that can be charged to expense.

What are the tax implications of depletion?

In particular, a company that extracts resources will use depletion to account for the use of these assets. One method of calculating depletion expense is the percentage depletion method. It assigns a fixed percentage to gross revenue—sales minus costs—to allocate expenses. 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.

• In some countries, depletion is treated as a deductible expense for tax purposes.
• For example, if a large piece of machinery or property requires a large cash outlay, it can be expensed over its usable life, rather than in the individual period during which the cash outlay occurred.
• Only natural resources can deplete since there’s a limited amount of each type available.
• Depletion, for both accounting purposes and United States tax purposes, is a method of recording the gradual expense or use of natural resources over time.
• The fixed percentage gets multiplied by the gross income to find the total capitalized costs depleted.
• Examples of depletion involve the logical expensing of a company’s cost of natural resources such as oil, natural gas, coal, metals, stone, etc.
• Depreciation typically relates to tangible assets, like equipment, machinery, and buildings.

It follows the same process used in Depreciation, which is an accounting technique used to allocate the cost of tangible assets over their useful lives. The estimated amount of a natural resource that can be recovered will change constantly as assets are gradually extracted from a property. As you revise your estimates of the remaining amount of extractable natural resource, incorporate these estimates into the unit depletion rate for the remaining amount to be extracted. Depletion is an accrual accounting technique used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth.