By using the units remaining at the end of the year, the adjustment allows for revised estimates of the reserves. Conceptually, depletion is similar to the depreciation of property, plant and equipment. Any opinions, analyses, reviews or recommendations expressed here are those of the author’s alone, and have not been reviewed, approved or otherwise endorsed by any financial institution. For related information, read about how to account for depletion and other non-cash charges. 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. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.
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 what is an amazon resource name arn definition from searchaws cost is based on the units extracted or used for a given time period. Cost depletion is an accounting method by which costs of natural resources are allocated to depletion over the period that make up the life of the asset.
What is the purpose of depletion in accounting?
Unlike depreciation, cost depletion is based on usage and must be calculated every period. 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. This means that the unit depletion charge will increase to $1.61 ($450,000 remaining depletion base / 280,000 barrels). Pensive’s geologists estimate that the proven oil reserves that are accessed by the well are 400,000 barrels, so the unit depletion charge will be $1.50 per barrel of oil extracted ($600,000 depletion base / 400,000 barrels).
- Unlike depreciation, cost depletion is based on usage and must be calculated every period.
- This means that the unit depletion charge will increase to $1.61 ($450,000 remaining depletion base / 280,000 barrels).
- Depreciation, depletion, and amortization (D&A) refers to the set of techniques used to gradually charge certain costs to expense over an extended period of time.
- In the first year, Pensive Oil extracts 100,000 barrels of oil from the well, which results in a depletion charge of $150,000 (100,000 barrels x $1.50 unit depletion charge).
- Like depreciation and amortization, depletion is a non-cash expense that lowers the cost value of an asset incrementally through scheduled charges to income.
- Examples of depletion involve the logical expensing of a company’s cost of natural resources such as oil, natural gas, coal, metals, stone, etc.
In 2009, X’s share of production sold was 40,000 barrels and an engineer’s report indicated that 160,000 barrels could be recovered after December 31, 2009. The resulting net carrying amount of natural resources still on the books of a business do not necessarily reflect the market value of the underlying natural resources. Rather, the amount simply reflects an ongoing reduction in the amount of the original recorded cost of the natural resources. For tax purposes, the two types of depletion are percentage depletion and cost depletion.
DD&A Under the Successful Efforts Method
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. The other method of depletion is percentage depletion, which is calculated by multiplying the gross income received in the tax year from extracting a resource by an IRS-determined percentage established for each resource. For example, if the percentage were 22%, depletion expense would be gross income times 22%.
Reserves generally include proven developed reserves and “probable” or “prospective” reserves if there is reasonable evidence to have believed that such quantities existed at that time.
The use of depreciation is intended to spread expense recognition for fixed assets over the period of time when a business expects to earn revenue from those assets. Amortization is the same concept, but is applied to the consumption of an intangible asset over its useful life. In the oil and gas industry, amortization is used more broadly to refer to the ongoing expensing of properties, wells and equipment so that it becomes part of the cost of the oil and gas produced. All of these terms are classified as non-cash expenses, since no cash outflows occur when these charges are made. 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.
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As natural resources are extracted, they are counted and taken out from the property’s basis. Depreciation, depletion, and amortization (D&A) refers to the set of techniques used to gradually charge certain costs to expense over an extended period of time. The planned, gradual reduction in the recorded value of a tangible asset over its useful life is referred to as depreciation.
It requires the method that yields the highest deduction to be used with mineral property, which it defines as oil and gas wells, mines, and other natural deposits, including geothermal deposits. The depletion concept is used in accounting to charge the costs of natural resource extraction to expense as those resources are being used. Depletion can be considered a variable cost, since it is closely linked to the rate at which resources are consumed. This varies from the fixed cost treatment that is accorded to depreciation and amortization, since these types of expensing mechanisms do not vary with activity levels. During the second year, Pensive Oil extracts 80,000 barrels of oil from the well, which results in a depletion charge of $128,800 (80,000 barrels x $1.61 unit depletion charge).
In addition, Pensive Oil estimates that it will incur a site restoration cost of $57,000 once extraction is complete, so the total depletion base of the property is $600,000. Companies engaged in mining or extracting identify their depletion expense https://www.bookkeeping-reviews.com/11-data-ownership-security-privacy-both-myob-and/ methods and comment on period expenses in the management discussion and analysis (MD&A) sections of their quarterly and annual filings. Units are considered sold in the year the proceeds are taxable under the taxpayer’s accounting method.
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In accounting, depletion refers to the expensing of a company’s cost of a natural resource. Ultimately, it means moving a natural resource’s cost from the company’s balance sheet to the company’s income statements as the natural resource is being sold. The percentage depletion method requires a lot of estimates and is, therefore, not a heavily relied upon or accepted method of depletion. The objective of depletion is to match the cost of the natural resources that were sold with the revenues from the natural resources that were sold.
At the end of the second year, there is still a depletion base of $321,200 that must be charged to expense in proportion to the amount of any remaining extractions. Depletion is an accrual accounting technique used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. Thus, if you extract 500 barrels of oil and the unit depletion rate is $5.00 per barrel, then you charge $2,500 to depletion expense.
