Definition
In financial accounting, depletion is used to capture the decline in a natural resource such as petroleum, timber, and minerals. Natural resources subject to depletion can be identified by one of two features:
The asset can be completely consumed
The asset can only be replaced by nature
Calculation
Depletion = Cost Basis for Resource x (Units Extracted or Harvested / Total Units)
Explanation
In order to calculate depletion, the company must first determine the depletion base, or cost of the natural resource. These costs generally fall into three categories:
Cost to acquire the resource
Cost to develop the resource
Costs associated with exploration of the resource
There is considerable controversy surrounding the depletion base for oil and gas reserves, due to the difficulty in estimating recoverable reserves.
Example
Timber Company owns 50,000 acres of harvestable trees, which were purchased for $10,000,000. The company clears 5,000 acres in year one. The depletion deduction would be:
= $10,000,000 x (5,000 / 50,000) = $10,000,000 x 0.10, or $1,000,000
This example uses the cost depletion method of accounting, which is used by most companies. Alternatively, a percentage depletion method can be used.
Related Terms
The accounting term used to describe an economic resource, which is owned by the corporation and expected to provide future benefits to its operation, is asset. Appearing on the balance sheet, assets are typically broken down into two categories:
Moneyzine EditorJanuary 5th, 2024
The financial accounting term depreciation is sometimes defined as a decline in tangible plant's service potential. Depreciation is a method of allocating the cost of a tangible asset in a systematic manner to those time periods that benefit from the use of the asset.Moneyzine EditorJanuary 16th, 2024
The accounting term used to describe the expiration of intangible assets such as patents or goodwill is amortization. As is the case with the depreciation of a tangible asset, the amortization of an intangible asset is shown on the income statement as an expense of the company; thereby reducing net income over the years this benefit is realized.Moneyzine EditorJanuary 5th, 2024
The financial accounting term depletion refers to the allocation of cost to an accounting period as units of a natural resource are mined, cut, pumped or otherwise harvested or consumed.Moneyzine EditorSeptember 19th, 2023
The financial accounting term depletion base refers to the total cost associated with assets that are a natural resource too. The depletion base typically includes three costs: acquisition, exploration and development. This base is the value used when determining the company's depletion expense.Moneyzine EditorJanuary 15th, 2024- The term recoverable reserves is used in the natural resource industry to describe assets considered economically and technically feasible to extract. The process of estimating recoverable reserves relies on the expertise of subject matter experts, and estimates will change as processes become more sophisticated.Moneyzine EditorSeptember 21st, 2023
The term discovery value accounting refers to an accounting method used in the natural resources industry when there is a change in extractable assets. Also known as reserve recognition accounting in the oil and gas industry, this approach allows companies to adjust their financial statements for these changes.Moneyzine EditorJanuary 16th, 2024
