Detailed Definition
Depletion Accounting refers to the systematic allocation of the cost of a wasting asset over the period it is being used. A wasting asset is any natural resource, such as minerals, oil, natural gas, and timber, that diminishes over time as it is converted into sales and profits. Depletion is particularly crucial in industries like mining, oil, and gas, where it serves to provide a more accurate picture of both the financial performance and the resource levels over time. The primary objective of depletion accounting is to match the cost of the natural resource against the revenue it generates.
Types of Depletion
- Percentage Depletion: This involves applying a fixed percentage rate based on the gross income derived from the resource, regardless of the property’s cost.
- Cost Depletion: This involves determining the total quantity of the resource and then calculating the cost per unit that can be depleted in that period.
Examples
- Oil Field: An oil company extracts 10,000 barrels of oil in a year from a known reserve of 100,000 barrels. If the land and extraction-related costs are valued at $1 million, the cost depletion per barrel is $10.000/bbl.
- Coal Mine: A coal mining company extracts 100,000 tons of coal out of an estimated reserve of 1,000,000 tons. If the mine was acquired for $500,000, the depletion per ton is calculated at $0.50/ton.
Frequently Asked Questions
How is depletion different from depreciation?
Depletion is specifically used for natural resources that get consumed (or ‘wasted’) while depreciation applies to tangible assets like machinery, buildings, equipment which degrade over time.
Is depletion calculated annually?
Yes, depletion is typically calculated on an annual basis as part of the end-of-year accounting processes.
What industries commonly use depletion accounting?
Mainly extractive industries such as mining, petroleum, gas extraction, and timber harvesting.
Can depletion be used for intangible assets?
No, depletion is used for natural resources. Intangible assets would use another method such as amortization.
How does percentage depletion work?
Percentage depletion applies a consistent percentage to the gross revenue derived from the resource, without considering the initial cost.
What is required to calculate cost depletion?
To calculate cost depletion, information including the total capitalized cost of the resource, the total recovered quantities, and the remaining extractable quantities are needed.
- Depreciation: A method of allocating the cost of a tangible fixed asset over its useful life.
- Wasting Asset: A resource that gets depleted over time through usage, extraction, or consumption.
- Residual Value: The estimated amount that a company can realize upon disposal of an asset after its useful life.
- Intangible Asset: Non-physical assets such as patents, copyrights, and trademarks.
Online References
- Investopedia on Depletion
- IRS Depletion Guidelines
Suggested Books for Further Studies
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield.
- “Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso.
- “Financial & Managerial Accounting” by Carl Warren, James M. Reeve, and Jonathan Duchac.
Accounting Basics: “Depletion Accounting” Fundamentals Quiz
### Is depletion only applicable to natural resources?
- [x] Yes, it applies to natural resources such as minerals, oil, and timber.
- [ ] No, it applies to all types of assets.
- [ ] Yes, it applies only to intangible resources.
- [ ] No, it applies to both natural resources and tangible fixed assets.
> **Explanation:** Depletion is specifically designed for natural resource assets like minerals, oil, natural gas, and timber, which get consumed over time.
### What is the primary objective of depletion accounting?
- [x] To match the cost of the natural resource against the revenue it generates.
- [ ] To increase the asset value over time.
- [ ] To spread the cost equally over all assets.
- [ ] To enhance the marketability of the assets.
> **Explanation:** The main goal of depletion accounting is to allocate the cost of the resource proportionately to its revenue-generating usage.
### How would a company use cost depletion for a coal mine?
- [x] By calculating the cost per ton based on the total capitalized cost and the remaining extractable quantities.
- [ ] By applying a fixed percentage on gross income derived from coal extraction.
- [ ] By using assortment value of identified coal and recoverable value.
- [ ] By reinvesting profits into further extractions.
> **Explanation:** Cost depletion involves calculating the cost per unit of the resource that can be depleted, based on the initial acquisition cost and total extractable quantity.
### Does depletion apply to both natural and intangible assets?
- [ ] Yes, it applies to both.
- [ ] No, it only applies to intangible assets.
- [x] No, it only applies to natural resources.
- [ ] Yes, but in different scenarios.
> **Explanation:** Depletion applies specifically to natural resources, while intangible assets use amortization.
### What method applies a fixed percentage rate irrespective of initial cost?
- [ ] Cost Depletion
- [x] Percentage Depletion
- [ ] Linear Depletion
- [ ] Time Depletion
> **Explanation:** Percentage depletion applies a fixed percentage of the gross income derived from the resource, irrespective of the property's cost.
### What is a vital input required for calculating cost depletion?
- [x] Total capitalized cost and the remaining extractable quantities.
- [ ] Historical gross income derived from the resource.
- [ ] Number of employees working on extraction.
- [ ] The overall economic value of the land.
> **Explanation:** To calculate cost depletion, the total capitalized cost of the resource and the remaining quantities yet to be extracted are essential.
### Which industry does not commonly use depletion accounting?
- [ ] Mining
- [ ] Oil Extraction
- [ ] Timber Harvesting
- [x] Manufacturing
> **Explanation:** Depletion is used for natural resource extraction industries. Manufacturing typically does not use depletion but rather applies depreciation to its tangible fixed assets.
### How is the depletion per unit determined in cost depletion method?
- [ ] By assessing current market prices.
- [x] By dividing the total capitalized cost by the estimated recoverable units.
- [ ] By evaluating employee output.
- [ ] By investments into resource exploration.
> **Explanation:** In the cost depletion method, the total capitalized cost is divided by the total recoverable units to determine depletion per unit.
### What happens if a resource reserve estimate changes?
- [x] The rate of depletion will adjust based on the new reserve estimates.
- [ ] Depletion continues at the initial rate.
- [ ] The asset is re-evaluated for depreciation.
- [ ] Financial statements need not be updated.
> **Explanation:** If reserve estimates change, the rate of depletion will be adjusted according to the new estimates to reflect an accurate remaining usable resource.
### In depletion accounting, how is the value of the resource recorded?
- [x] As an asset on the balance sheet, reduced over time by depletion.
- [ ] Just as an expense on the income statement.
- [ ] As a stock market value.
- [ ] Recorded under operating cash flows.
> **Explanation:** The value of the resource is recorded as an asset on the balance sheet and is systematically reduced by the depletion expense over time.
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