What is Depletion?
Depletion is a method of accrual accounting that’s quite similar to depreciation and amortization, but it’s a bit different. It’s used to allocate the cost of extracting natural resources like minerals, wood, or oil from the mother earth.
Just like depreciation and amortization, depletion doesn't involve actual cash going out. Instead, it's a way to gradually lower the recorded value of these resources over time by making regular adjustments to the books. But what makes depletion special is that it's all about the slight decrease in the amount of these natural resources available rather than the wearing down of things like machines or the lifespan of intangible assets.
Understanding Depletion
In accounting and financial reporting, depletion serves a key role in correctly valuing assets on the balance sheet and documenting expenses on the income statement in the right time frame.
When we talk about the costs tied to extracting natural resources, we follow a systematic approach. These costs are allocated over different periods based on how much of these resources we actually extract. These costs sit on the balance sheet until it's time to recognize them as expenses.
There are essentially two main types of depletion allowances: percentage depletion and cost depletion.
To figure out which costs should be allocated for using these natural resources, we need to consider every step of the process. The foundation of depletion is all about the capitalized costs that get gradually reduced over several accounting periods.
How can depletion be calculated?
First, subtract the salvage value of the asset from the depletion base. This will give you the amount that needs to be depleted over time.
Next, divide this amount by the total number of units you plan to recover. This simple calculation will give you the unit depletion rate:
(Unit Depletion Rate) = (Depletion Base - Salvage Value) / Total Units to Be Recovered.
Now, to calculate the depletion expenses for a specific period, apply the unit depletion rate to the number of units extracted. Here's the formula in your preferred style:
Depletion Expenses = (Cost - Salvage Value) / Estimated Number of Units) * Number of Units Extracte