Depletion expense

Depletion expense - the term describing a periodic assignment to the expense of recorded amounts or the allowable deduction from income tax that is related to the exhaustion of mineral reserves. Depletion is included as one of the components of amortization .

Depletion is also the annual expense for the use of natural resources (e.g. timber, minerals, oil) .

Depletion base

The depletion base includes the following elements :

• Development costs - intangible development costs like wells, shafts, tunnels
• Acquisition costs - cost to obtain property rights through lease or purchase
• Restoration costs - the costs of restoring the property to its natural state at the end of the extraction of natural resources.
• Exploration costs - these costs are expensed as incurred

The amount of periodic depletion is computed by multiplying the number of minerals extracted during the period by a depletion rate. Depletion rate is computed by dividing the cost of the mineral deposit by its estimated total units of resource. The entry to record depletion debits a depletion expense account and credits an accumulated depletion account .

Coefficient of depletion

The unit depletion rate is systematically revised due to the uncertainties surrounding the recovery of natural resources. Revisions are made prospectively; the remaining undepleted cost is allocated over the remaining expected recoverable units .

Examples of Depletion expense

• Depletion expense is often used in industries that involve the extraction of natural resources, such as mining and oil and gas. For instance, a company that owns a mineral reserve will periodically deduct a portion of the value of the reserve from their profits in order to account for the cost of extracting the minerals. This is referred to as depletion expense.
• Another example of depletion expense is the deduction of a portion of the value of timberland from a company’s profits. Timberland is an asset that can be harvested and sold, and the cost of harvesting the timber must be taken into account when calculating profits.
• A third example of depletion expense is the deduction of a portion of the value of an oil field from a company’s profits. The cost of extracting the oil must be taken into account when calculating profits, and this cost is deducted as a depletion expense.

Advantages of Depletion expense

Depletion expense provides several advantages for businesses in the natural resources industry. These include:

• The ability to account for the cost of extracting natural resources over time, instead of incurring the entire expense in a single year. This helps to more accurately reflect the true cost of the resource.
• The ability to spread out the cost of the resource over the lifetime of the resource, which can help to reduce the impact of the cost on current profits.
• The ability to accurately calculate and report the cost of the resource to shareholders and other interested parties. This helps to ensure that the company is accurately reflecting the true value of the resource.
• The ability to accurately record the depletion of the resource over time, which can help to ensure that the company is managing the resource responsibly.
• The ability to take advantage of certain tax deductions related to the depletion expense, which can help to reduce the company’s overall tax liability.

Limitations of Depletion expense

Depletion expense is an important tool for businesses to recognize and record the costs associated with the extraction of natural resources. However, there are some limitations associated with this expense that must be taken into account, such as:

• The cost of depletion is based on estimates, which can be inaccurate leading to over or under depreciation of the asset.
• Depletion expense does not provide a realistic assessment of the costs of the natural resource's extraction.
• Depletion expense does not consider the potential environmental impact of the extraction of the natural resource.
• Depletion expense does not account for the potential for the natural resource to be replaced or regenerated.
• Depletion expense does not take into account the potential for the natural resource to be replaced or regenerated in the future, as this is not reflected in the current expense.

Other approaches related to Depletion expense

Depletion expense is a term used to describe the periodic assignment to the expense of recorded amounts or the allowable deduction from income tax that is related to the exhaustion of mineral reserves. Other approaches related to depletion expense include:

• Depletion allowance - A tax deduction, allowed by the Internal Revenue Service, for the depletion of natural resources. This deduction is typically allowed as a percentage of the gross income from the sale of the resources.
• Depletion accounting - A method of accounting used to allocate the cost of natural resources over the life of a production cycle. It is a non-cash expense and is treated as an adjustment to the cost of goods sold.
• Oil and gas depletion allowance - A tax deduction allowed to taxpayers who own or lease oil and gas properties. This deduction is intended to compensate taxpayers for the exhaustion of their reserves of oil and gas.

In summary, depletion expense is a term used to refer to the periodic assignment of expenses related to the exhaustion of mineral reserves. Other approaches related to depletion expense include depletion allowance, depletion accounting, and oil and gas depletion allowance.

Footnotes

Depletion expense — recommended articles

Annual depreciation — Depreciation rate — Non-operating expense — Unearned Premium — Gross fixed assets — Book profit — Accrued income — Depreciable cost — Underlying Profit

References

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• Maxfield P.C., Miller J.A., Allen R.M. (2019)., Taxation of Mining Operations, LexisNexis
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Author: Klaudia Szydłowska