What is meant by Depletion? – Definition
Depletion is the process in which natural resources lose their benefits as the resources are removed. It follows the same process as units of production depreciation.
The cost of natural resources extracted by a firm from property is known as depletion and is based on the same concepts as depreciation. Because the usefulness of the resources to the firm is generally directly proportional to the amount extracted (or otherwise removed), the output-oriented units of production approach is widely used for allocating the cost to the materials and the time periods in which they are used. While the numerator (units produced in the period) is usually reliably measurable, the denominator (units available from the property) is often impossible to measure precisely. Nonetheless, the approach is more rational than others and is virtually always used.
The salvage value of the property tends to be more significant for natural resource producing property and should be included in computing the lifetime depletion to be recorded. As with amortization, the usual procedure results in recording the credit half of the depletion entry directly in the asset account, despite the potential usefulness of showing the proportionate amounts of cost consumed and left to be consumed.
Cost depletion (which is required under GAAP) should not be confused with percentage depletion deductions allowed by the income tax laws. Under these provisions, a producer is allowed to deduct an arbitrary fixed percentage of gross income as “depletion expense” without regard to the historical cost of the property.
A side issue related to depletion concerns the amortization and depreciation of costs incurred to prepare the property for production. These expenditures may relate to legal, environmental, and laboratory studies, as well as tangible property such as buildings and processing equipment.
In situations where the consumption of the usefulness of these assets parallels the production of the resource, they may be amortized and depreciated on a units-of-production approach. In other cases, they should be amortized and depreciated according to a pattern that reflects the consumption of their usefulness.