Depletion: Definition

Depletion is the process by which natural resources lose their benefits as the resources are removed. It follows the same process used in the units of production method of depreciation.

Depletion: Explanation

The cost of natural resources extracted by a firm from a property is known as depletion. It is based on the same concepts as depreciation.

The usefulness of resources to a firm is generally directly proportional to the amount extracted (or otherwise removed).

Therefore, the output-oriented units of production approach is widely used to allocate 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. However, the approach is better 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 a 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 using the units of production approach.

In other cases, they should be amortized and depreciated based on a pattern that reflects the consumption of their usefulness.

Frequently Asked Questions

What is depletion?

Depletion is the process by which natural resources lose their benefits as they are removed. 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.

How is depletion calculated?

The depletion expense is calculated by estimating the total amount of revenue that will be generated from the extraction and production of the natural resource, and then dividing that amount by the estimated number of units that will be extracted or produced. This calculation results in a depletion expense per unit that is charged against the revenue generated from the natural resource.

What are the tax implications of depletion?

The tax implications of depletion depend on the country in which the natural resources are located. In some countries, depletion is treated as a deductible expense for tax purposes. In other countries, depletion may be subject to special taxes or royalties.

What are some common methods of accounting for depletion?

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.

What factors affect depletion?

Depletion is affected by a number of factors, including the type of asset being depleted, the rate at which it is depleted, and the method used to calculate depletion.

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