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Depletion: Definition, 4 Affecting Factors, and Depletion Methods

the accumulated depletion account is

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.

Accounting for Natural Resource Assets & Depletion

  • Accumulated depletion increases over time as more of the resource is extracted, reflecting the reduction in the resource’s value.
  • Depreciation is the accounting term used for assets such as buildings, furniture and fittings, equipment etc.
  • Typically, we record natural resources at their cost of acquisition plus exploration and development costs; on the balance sheet, we report them at total cost less accumulated depletion.
  • You should be familiar with the definition of an asset in a company and how to account for them on the balance sheet.
  • 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.
  • On the balance sheet, we classify natural resources as a separate group among noncurrent assets under headings such as “Timber stands” and “Oil reserves”.
  • The cumulative amount of depletion expense pertaining to the natural resources shown on the balance sheet.

However, you may not know how an asset such as land with minerals is handled in accounting. Instead, in the absence of natural resources that are to be extracted (see below), land is considered to have an unlimited life span. By crediting the Accumulated Depletion account instead of the asset account, we continue to report the original cost of the entire natural resource on the financial statements. To determine the total cost of the resource available, we combine this depletion cost with other extraction, mining, or removal costs.

Depletion: Definition, 4 Affecting Factors, and Depletion Methods

A single line providing the dollar amount of charges for the accounting period appears on the income statement. Depletion for accounting and financial reporting purposes is meant to assist in accurately identifying the value of the assets on the balance sheet and recording expenses in the appropriate time period on the income statement. Like depreciation and amortization, depletion is a non-cash expense that lowers the cost value of an asset incrementally through scheduled charges to income. Where depletion differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or aging life of intangibles.

As natural resources are extracted, they are counted and taken out from the property’s basis. Depletion expense is typically calculated using either the Unit-of-Production method or the percentage depletion method. The Unit-of-Production method divides the cost of the resource by the total estimated units of production and multiplies it by the units extracted during the period.

  • Plant assets and natural resources are tangible assets used by a company to produce revenues.
  • In conclusion, depletion is an essential concept in accounting, particularly for companies operating in industries where natural resources are extracted and exploited.
  • 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.
  • Accrual accounting permits companies to recognize capital expenses in periods that reflect the use of the related capital asset.
  • 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.

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. Chevron Corp. (CVX) reported $19.4 billion in the accumulated depletion account is 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. To calculate accumulated depletion, you need to determine the depletion rate per unit of the resource and multiply it by the number of units extracted during a specific accounting period. 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.

Fundamentals of Accumulated Depletion: Accounting Basics Quiz

the accumulated depletion account is

The company would then expense $1 per barrel of oil extracted against its income statement. The percentage depletion method requires a lot of estimates and is, therefore, not a heavily relied upon or accepted method of depletion. The dollar amount represents the cumulative total amount of depreciation, depletion, and amortization (DD&A) from the time the assets were acquired. 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. Accrual accounting permits companies to recognize capital expenses in periods that reflect the use of the related capital asset.

How is depletion expense calculated?

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. The yearly depletion cost is based on the units extracted or used for a given time period. Plant assets and natural resources are tangible assets used by a company to produce revenues. On the income statement, depreciation expense is recorded for plant assets and depletion expense is recorded for natural resources.

During this useful life, they are depreciated, which reduces their cost to what they are supposed to be worth at the end of their useful lives (which is known as salvage value). Accumulated depletion is a contra-asset account recorded on the balance sheet that reflects the total amount of depletion expense that has been allocated over the lifespan of a depletable natural resource. Depletion is an accounting method similar to depreciation and amortization, but it is specifically used for natural resources such as mines, oil fields, and timber. Depreciation is calculated taking the cost of the asset, the expected useful life of the asset, residual value of the asset and percentage where necessary. In the context of natural resources, such as minerals, timber, or oil and gas, depletion is similar to depreciation for tangible assets and amortization for intangible assets.

It represents the total amount of a natural resource’s original cost that has been used up or depleted through the extraction or consumption process. Accumulated depletion is recorded on a company’s balance sheet as a contra asset account, which reduces the value of the natural resource asset. Depletion can be calculated on a cost or percentage basis, and businesses generally must use whichever provides the larger deduction for tax purposes. Nearly all fixed assets have a useful life, after which they no longer contribute to the operations of a company or they stop generating revenue.

Accumulated depletion increases over time as more of the resource is extracted, reflecting the reduction in the resource’s value. Depletion is the exhaustion that results from the physical removal of a part of a natural resource. In each accounting period, the depletion recognized is an estimate of the cost of the natural resource that was removed from its natural setting during the period. To record depletion, debit a Depletion account and credit an Accumulated Depletion account, which is a contra account to the natural resource asset account. Cost depletion is calculated by taking the property’s basis, total recoverable reserves and number of units sold into account.

Hence, these methods help the company to record the asset / resource’s value as it reduces due to the usage, and hence, help to understand its value at a given time. Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction. Enterprises with an economic interest in mineral property or standing timber may recognize depletion expenses against those assets as they are used.

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