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Depletion Base

Moneyzine Editor
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Moneyzine Editor
2 mins
January 15th, 2024
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Depletion Base

Definition

The financial accounting term depletion base refers to the total cost associated with assets that are a natural resource too. The depletion base typically includes three costs: acquisition, exploration and development. This base is the value used when determining the company's depletion expense.

Calculation

Depletion Base = Cost to Acquire + Cost to Explore + Cost to Develop

Explanation

The term depletion is associated with assets that are considered natural resources. Typically, these are assets that are consumed and only replaced by nature. Examples of natural resources include timber, mineral ores, oil and natural gas deposits.

While assets such as property, plant and equipment are depreciated over their serviceable lives, natural resources are subject to depletion. In order for companies to calculate this expense, they must first determine the depletion base. The costs associated with assets that are natural resources fall into three categories:

  • Acquisition: the price paid for known resources or the rights to search and discover a natural resource.

  • Exploration: the costs associated with discovering a natural resource. Some companies will capitalize the costs of unsuccessful efforts in addition to successful exploration efforts. This is referred to as the full-cost approach. Companies that follow this method believe the unsuccessful efforts are the true cost of discovering a resource. Companies may also follow the successful efforts approach and only capitalize the fruitful efforts, while expensing ineffective ones.

  • Development: the costs associated with extracting a resource fall into two categories: intangible and tangible development costs. Tangible costs include the physical assets needed to extract the resource. Examples include oil rigs, drills, and other heavy equipment. Tangible costs are NOT included in the depletion base, but are depreciated in the same way as other property, plant, and equipment. Intangible assets include those costs associated with drilling, tunneling or otherwise gaining access to the natural resource. Intangible assets are included as part of the depletion base.

Related Terms

  • Assets
    The accounting term used to describe an economic resource, which is owned by the corporation and expected to provide future benefits to its operation, is asset. Appearing on the balance sheet, assets are typically broken down into two categories:
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  • The financial accounting term property, plant, and equipment is used to describe assets of a long lasting nature, which are used in the normal operation of the company. The most common types of property, plant, and equipment are land, buildings, and machinery.
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  • The financial accounting term service life is used to describe the period of time over which an asset can be expected to perform its intended use. Service life is typically limited by two factors: physical wear and obsolescence.
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  • Depreciation
    The financial accounting term depreciation is sometimes defined as a decline in tangible plant's service potential. Depreciation is a method of allocating the cost of a tangible asset in a systematic manner to those time periods that benefit from the use of the asset.
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  • Amortization
    The accounting term used to describe the expiration of intangible assets such as patents or goodwill is amortization. As is the case with the depreciation of a tangible asset, the amortization of an intangible asset is shown on the income statement as an expense of the company; thereby reducing net income over the years this benefit is realized.
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  • Depletion Expense
    The financial accounting term depletion refers to the allocation of cost to an accounting period as units of a natural resource are mined, cut, pumped or otherwise harvested or consumed.
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  • Discovery Value Accounting
    The term discovery value accounting refers to an accounting method used in the natural resources industry when there is a change in extractable assets. Also known as reserve recognition accounting in the oil and gas industry, this approach allows companies to adjust their financial statements for these changes.
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  • The term recoverable reserves is used in the natural resource industry to describe assets considered economically and technically feasible to extract. The process of estimating recoverable reserves relies on the expertise of subject matter experts, and estimates will change as processes become more sophisticated.
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