The depletion rate can be calculated as a percentage term of total costs or per unit basis. In a percentage method, the calculation is based on the units extracted in the current period and expressed in terms of the percentage of the total estimated resources. In the dollar-value method or cost method, the depletion rate is simply the current period extracted unit cost in unit terms. The second method of calculating depletion is thecost depletion method. Cost depletion is calculated by taking the property’s basis, total recoverable reserves and number of units sold into account.

For that purpose, property is each separate interest businesses own in each mineral deposit in each separate tract or parcel of land. Businesses can treat two or more separate interests as one property or as separate properties. Acquisition refers to the total expenses or costs associated with leasing or purchasing land, including ownership rights. The cost of acquisition depends on the size of the land and the estimated value of the natural resources that the land contains. When the land purchase or lease concludes as planned, then a company converts the acquisition costs to exploration costs.

## How To Deduct Property Taxes On A Home Based Business

Over the course of the first year, BJ successfully drills and extracts 100,000 gallons of oil and sells it to his resellers and refineries. In this case Lydia, would divide the \$300,000 she paid for the land by 600,000 tons of estimated coal to come up with \$.50 per ton. She would now multiply the \$.50 per ton times the number of tons removed to come up with a depletion amount of \$50,000. Both forms of mining, as well as petroleum drilling and timberland use, are all related to depletion.

The accrual accounting method of depletion is used to allocate costs for natural resources over the estimated total value of the resources. Depletion helps identify the accurate value of the balance sheet assets and record costs on the income statement in a certain period. First, a company capitalizes on the costs of the natural resource extraction, meaning that they record an expense without what are retained earnings paying for that expense in full. Next, a company allocates the expenses of the natural resources across various time periods. The costs of the natural resource extraction remain on the company’s budget sheets until they have recognized the full expense. The cost of a natural resource is divided by the estimated units in the resource deposit; the resulting amount is depletion per unit.

Conversely, the train that runs on the track can be relocated and used elsewhere; as such it would likely be depreciated over the life of the train rather than the life of the mine. The number of units sold during the tax year is based on the accounting method used.

An attractive element of percentage depletion is that the cumulative depletion deductions may be greater than the capital amount spent by the taxpayer to acquire the property. Cost depletion is an accounting method by which costs of natural resources are allocated to depletion over the period that make up the life of the asset. Cost depletion is computed by estimating the total quantity of mineral or other resources acquired and assigning a proportionate amount of the total resource cost to the quantity extracted in the period. For example, assume Big Texas Oil, Co. had discovered a large reserve of oil and estimates that the oil well will produce 200,000 barrels of oil. If the company invests \$100,000 to extract the oil and extracts 10,000 barrels the first year, the depletion deduction is \$5,000 (\$100,000 X 10,000/200,000).

The expected value of an asset at the end of its useful life is known as​ ________. The excess of the cost of an acquired company over the sum of the market value of its net assets is __________. The method is highly subjective adjusting entries especially the number of units to be extracted is difficult to estimate. This is used to present users with ads that are relevant to them according to the user profile.test_cookie15 minutesThis cookie is set by doubleclick.net.

The use of all three expensing strategies is typically associated with the acquisition, exploration, and development of new oil and natural gas reserves. If an entire stand of timber is sold in the same transaction, the depletion expense is equal to your cost basis in the timber. The calculation of depletion becomes more complicated if you sell only a portion of the timber. For a partial sale, you must determine the total volume of wood contained in your entire timber stand. It is determined by dividing the cost basis or adjusted basis of the timber by the total volume of timber on the tract of land represented by the account.

## What Is Cost Depletion?

The extraction of a large number of natural resources happens from beneath the ground for a variety of purposes. Scientifically, it’s not possible the quantum of resources below the earth’s surface before their extraction. This aspect has made accounting authorities conclude that natural bookkeeping resources should be recapitalized at cost initially. Subsequently, the expenses are allocated over the period until they are consumed. Depletion is an accrual accounting method used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth.

• Proven reserves are the best estimate of oil that will be extracted from a formation given the current technology, economic evaluation, and available data.
• Cost depletion is one of two accounting methods used to allocate the costs of extracting natural resources, such as timber, minerals, and oil, and to record those costs as operating expenses to reduce pretax income.
• The percentage depletion method requires a lot of estimates and is, therefore, not a heavily relied upon or accepted method of depletion.
• A portion of the original cost paid for the property must be allocated to the land, as well as other assets.

The only exception is when the alternative method, cost depletion, gives you a higher deduction. Under percentage depletion, the deduction for the recovery of one’s capital investment is a fixed percentage of the gross income from the sale of the oil or gas.

## Natural Resource Assets

It is important to note that the depletion expense should be recorded in the period that the extracted natural resource (e.g. coal) is sold. The unsold part of the extracted natural resource should be recorded as inventory. Charging depletion cost as an expense reduces assets book value from the balance sheet simultaneously.

The purpose of the cookie is to determine if the user’s browser supports cookies. CookieDurationDescriptioncookielawinfo-checbox-analytics11 monthsThis cookie is set by GDPR Cookie Consent plugin. The value derived will be divided by a total estimated number of product units. Depletion ExpenseDebitAccumulated DepletionCreditThe previous video gave us a demonstration of the accounting process for depletion but we will review it here. GAAP Generally accepted accounting principles are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors. The Internal Revenue Service requires the cost method to be used with timber.

## Calculating Depletion With The Cost Method

The depletion deduction allows an owner or operator to account for the reduction of a product’s reserves. The number of units that you sell to a timber buyer is multiplied by the unit cost to arrive at your depletion deduction. Depletion is entered on your tax return as an expense to offset the income reported from the timber sale. Your cost basis in the remaining portion of the timber stand is reduced by the amount of depletion expense taken. Unlike business assets that are depreciated, natural resources are expensed through depletion. An asset is depreciated or depleted to recover the original cost of the asset.

## What Is A Depletion Expense?

Charging these expenses as cost helps determine actual profits and identify the company’s actual financial position as on the balance sheet date. When the cost of extraction of natural resources has been capitalized, these expenses are allocated across the leasing period/ utilization period based upon their extraction. Plant assets and natural resources are tangible assets used by a company to produce revenues. On the income statement, depreciation expense is recorded for plant assets and depletion expense calculate depletion expense is recorded for natural resources. On the balance sheet, accumulated depreciation appears with the related plant asset account and accumulated depletion appears with the related natural resource account. Cost depletion is one of two accounting methods used to allocate the costs of extracting natural resources, such as timber, minerals, and oil, and to record those costs as operating expenses to reduce pretax income. The yearly depletion cost is based on the units extracted or used for a given time period.

There is various type of natural resources like oil, natural gas, coal etc. which are drilled out/ extracted out of the mineral-rich land. It is not possible to calculate the total value of resources present beneath the ground until they are extracted completely. GAAP usually makes it a mandatory requirement for companies engaged in mining to capitalise on the acquisition cost of the extracted resources. Depletion expense uses an accrual accounting system to allocate the cost of extracting natural resources. It is a non-cash expense like depreciation and amortization, which reduces the value of an asset incrementally via schedule charges on income. Depletion expenses are charged against revenue generated as a cost of natural resources utilization/ extraction.

The salvage value is what the item is worth at the end of its useful life. The process of decreasing the value of equipment is called depreciation. Accepted accounting procedures allow many methods of depreciation, such as the straight-line method, the double-declining method, and the sum of years’ method. Depreciation is the process of reducing the value of a long-term visible asset.

Therefore, depletion expense of \$5,000,000 might be recorded by debiting depletion expense for \$5,000,000 and crediting the gold mine for \$5,000,000. A landowner cannot use percentage depletion unless the landowner is a producer or royalty owner and their well produces natural gas that is either sold under a fixed contract or produced from geopressurized brine. To calculate the depletion per unit you take the total cost less salvage value and divide it by the total number of estimated units. The expense is calculated by multiplying the depletion per unit by the number of units consumed or sold during the current period. Depletion expenses can be described as an expense charged off in books of account against consumption, extraction of any mineral or other natural resource occupied or leased from government or any other person. The concept of depletion is similar to that of depreciation and amortization.