Instead, they use separate depreciation charges to allocate the costs of such equipment. Analysts and investors in the energy sector should be aware of this expense and how it relates to cash flow and capital expenditure. Third, the experience with RRA highlights the problems that accompany any proposed change from a historical cost to a fair value approach.
Liquidating Dividends
The amount included in the depletion base is the fair value of the obligation to restore the property after extraction. Companies sometimes incur substantial costs to restore the property to its natural state after extraction has occurred. Its proponents believe that the only relevant measure for a project is the cost directly related to it and that companies should report any remaining costs as period charges. They do so because they have new information or more sophisticated production processes available.
AccountingTools
MacLeod estimates that the mine will provide approximately 100,000 ounces of gold. The illustration below shows the computation of the depletion cost per unit (depletion rate). Because companies can move heavy equipment from one extracting site to another, companies do not normally include tangible equipment costs in the depletion base.
Accounting 101
Cost depletion is calculated by taking the property’s basis, total recoverable reserves and number of units sold into account. The property’s basis is distributed among the total number of recoverable units. As natural resources are extracted, they are counted and taken out from the property’s basis. One method of calculating depletion expense is the percentage depletion method. It assigns a fixed percentage to gross revenue—sales minus costs—to allocate expenses.
Depletion: Definition, 4 Affecting Factors, and Depletion Methods
- It does seem ironic that Congress directed the FASB to develop one method of accounting for the oil and gas industry, and when the FASB did so, the government chose not to accept it.
- In its footnotes, the energy giant revealed that the slight DD&A expense increase was due to higher production levels for certain oil and gas producing fields.
- For example, if a large piece of machinery or property requires a large cash outlay, it can be expensed over its usable life, rather than in the individual period during which the cash outlay occurred.
- Like depreciation and amortization, depletion is a non-cash expense that lowers the cost value of an asset incrementally through scheduled charges to income.
- Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction.
Smaller oil and gas companies often capitalize on these exploration costs. Thus, RRA is a fair value approach, in contrast to full-costing and successful efforts, which are historical cost approaches. Using the accumulated depletion of a natural resource is reported on the RRA would make a substantial difference in oil companies’ balance sheets and income statements. A company often owns a property from which it intends to extract natural resources as its only major asset.
A percentage of the purchase price is deducted over the course of the asset’s useful life. Accrual accounting permits companies to recognize capital expenses in periods that reflect the use of the related capital asset. In other words, it lets firms match expenses to the revenues they helped produce.
It requires the method that yields the highest deduction to be used with mineral property, which it defines as oil and gas wells, mines, and other natural deposits, including geothermal deposits. A major controversy relates to the accounting for exploration costs in the oil and gas industry. Conceptually, the question is whether unsuccessful ventures are a cost to those that are successful. The amount not sold remains in inventory and is reported in the current assets section of the balance sheet. A complete discussion of the accounting for restoration costs and related liabilities (sometimes referred to as asset retirement obligations). Like other long-lived assets, companies deduct from the depletion base any salvage value to be received on the property.
To record depletion, debit a Depletion account and credit an Accumulated Depletion account, which is a contra account to the natural resource asset account. Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction. Enterprises with an economic interest in mineral property or standing timber may recognize depletion expenses against those assets as they are used. Depletion can be calculated on a cost or percentage basis, and businesses generally must use whichever provides the larger deduction for tax purposes.
Depletion also lowers the cost value of an asset incrementally through scheduled charges to income. Where it differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or the aging life of intangibles. Depletion is an accrual accounting technique used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. On the other hand, intangible development costs are such items as drilling costs, tunnels, shafts, and wells.
