Depletion

Definition

In financial accounting, depletion is used to capture the decline in a natural resource such as petroleum, timber, and minerals. Natural resources subject to depletion can be identified by one of two features:

• The asset can be completely consumed
• The asset can only be replaced by nature

Calculation

Depletion = Cost Basis for Resource x (Units Extracted or Harvested / Total Units)

Explanation

In order to calculate depletion, the company must first determine the depletion base, or cost of the natural resource. These costs generally fall into three categories:

• Cost to acquire the resource
• Cost to develop the resource
• Costs associated with exploration of the resource

There is considerable controversy surrounding the depletion base for oil and gas reserves, due to the difficulty in estimating recoverable reserves.

Example

Timber Company owns 50,000 acres of harvestable trees, which were purchased for $10,000,000. The company clears 5,000 acres in year one. The depletion deduction would be:

= $10,000,000 x (5,000 / 50,000) = $10,000,000 x 0.10, or $1,000,000

This example uses the cost depletion method of accounting, which is used by most companies. Alternatively, a percentage depletion method can be used.

Related Terms

asset, depreciation, amortization, depletion expense, depletion base, recoverable reserves, discovery value accounting