Depletion Expense

calculate depletion expense

Instead, the natural resource that a company uses simply loses value over time. However, a company may normal balance entirely use up depreciable assets after some years, such as office or manufacturing equipment.

Gross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity. Every year after this, BJ will record a depletion expense until the full $1 million of cost is allocated to the asset. When the land was purchased on October 11 by Profits, Inc., the accountants created and debited the Land account for $300,000 and credited the Cash account for the same amount. At the end of the year, Profits, Inc. removed 100,000 tons of coal from the land.

calculate depletion expense

By using the units remaining at the end of the year, the adjustment allows for revised estimates of the reserves. Suppose the extracted units in our example remained 250,000 and 280,000 cubic feet for the next two periods respectively. CookieDurationDescriptionakavpau_ppsdsessionThis cookie is provided by Paypal. The cookie is used in context with transactions on the website.x-cdnThis cookie is set by PayPal. • Amounts recovered through depreciation deductions, deferred expenses, and deductions other than depletions.

The Formula For Depletion Expenses

When the property is purchased, a journal entry assigns the purchase price to the two assets purchased—the natural resource and the land. Depletion is a form of depreciation for mineral resources that allows for a deduction from taxable income to reflect the declining production of reserves over time. For oil and natural gas producers, percentage depletion is a small producer issue. In accounting, the company QuickBooks usually uses the units-of-activity method to calculate the depletion expense. This is due to the actual extracted resources usually fairly represents the exhaustion in each period of a natural resource that the company has invested in. Calculation of Depletion Expense – Finally, the units extracted for a period are multiplied depletion rate per unit in order to calculate the depletion expense for that period.

The value of the land is $300,000 minus the total accumulated depletion of $175,000 for a value at the end of year two of $125,000. We can record the adjusting journal entry by debiting depletion expenses and crediting natural resource assets. The cost per unit is then multiplied by the number of units extracted to calculate depletion. The second method of calculation depletion is the units of activity method. Companies calculate depletion expense use the units-of-activity method to divide the overall cost of a natural resource, minus salvage value, by the estimated number of units in the resource. The allowable statutory percentage depletion deduction is the lesser of net income or 15% of gross income. Depletion in accounting is a technique professionals use to estimate the total amount of money required to excavate any type of natural resource from the ground.

  • The cumulative depletion account is adjusted with each period accordingly.
  • The depletion deduction is taken in the year of sale to minimize any taxable gain.
  • In this case, with the result of the calculation, the depletion expense in 2020 is $228,000.
  • Any Salvage value of natural resources and project is subtracted from total base costs.
  • Gross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities.
  • Natural resource extraction requires several types of costs that incur before and during the extraction process.

Lydia knows that the land is not worth the same amount now as when she purchased it, but she needs to figure out how much it is worth as she begins to CARES Act prepare her taxes. For her first purchase, Lydia finds a plot of land that consists of 1,000 acres and is estimated to contain 600,000 tons of coal.

How Do I Report Depletion Deduction?

The method is simple to allocate costs for natural resources with the companies working in mines, timber, fishing, or oil sector etc. The depletion deduction is an important yet complex tax liability tool.

For example, Assume Mike Coal Company invests $20 million in a coal mine with a capacity of 2 million tons and no salvage value. Reserves generally include proven developed reserves and “probable” or “prospective” reserves if there is reasonable evidence to have believed that such quantities existed at that time.

What Is A Depletion Deduction?

The adjusted basis of property is the original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed and casualty losses. This method is extremely subjective, especially the estimated value of units to be extracted is difficult to calculate. Capital goods are tangible assets that a business uses to produce consumer goods or services. Buildings, machinery, and equipment are all examples of capital goods.

calculate depletion expense

In this article, we discuss what depletion in accounting is, explain how it works and provide examples. This calculator is for units of production method of depreciation of an asset or, the amount of depreciation for each unit and period. This calculation is equivalent to our units of activity depreciation calculator.


The basis usually includes the value of the land and its associated capital assets such as timber, equipment, buildings, and oil/gas. When establishing the basis, the landowner splits the value of the property at acquisition among these different capital assets. For the purpose of calculating the unit price, one should consider the total cost of natural resource acquisition reduced by the salvage value. Natural capital is a reference to the inventory of natural resources held by companies, such as natural gas or oil.

It’s impossible to accurately know how much resources are below the earth’s surface before they are extracted. That is whyGAAPrequires that natural resources be capitalized at cost initially. The purchase price or cost of the resources, mineral rights, and anything needed to prep the area for extraction is then allocated over the period of time they are consumed. Unlike depreciable assets, natural resources do not wear out (i.e. depreciate) with passage of time but they actually loose value when the resource is being extracted. An alternative to cost depletion is percentage depletion, where a mineral-specific percentage is multiplied by the gross income generated by a property during the tax year. Cost depletion is similar to depreciation, where the cost of a tangible asset is ratably charged to expense over a period of time.

How To Value Real Estate Investment Property

This term is commonly used in the case of any natural resource rather than in the case of fixed tangible or intangible asset. Where depletion differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or aging life of intangibles. The estimated capacity of the mine is 1,750,000 tons of coal and the estimated salvage value is zero. The company incurred additional $50,000 on development of mine for extraction purposes.

Three factors determine whether a landowner qualifies for the depletion deduction. First, the landowner must have an ownership interest in the mineral property. Second, the landowner must have a legal right to income from the oil and gas extraction. Third, the deduction is allowed only when oil or gas is actually sold and income is reportable. Therefore, this deduction is not an applicable deduction against lease bonus payments but is for royalty payments.

Are Depreciation And Amortization Included In Gross Profit?

Cost DepletionTo figure cost depletion, you must first determine the following. The total recoverable units of mineral in the property’s natural deposit. To figure the property’s basis for depletion, subtract all the following from the property’s adjusted basis. Depletion refers to an accrual accounting technique commonly used in the natural resources extracting industries such as mining, petroleum, timber, among others. What makes depletion similar to depreciation is that they are both cost recovery system for tax reporting and accounting.

Units of production is a differently worded version of our activity depreciation calculator. Which depreciation method always gives you the same amount of depreciation expense each year? Straight-line Units-of-production Double-declining-balance All methods always have the same amount of depreciation expense each year. As the estimated output has changed as a result of new survey conducted at the start of year 2, we must compute a new depletion rate to be used for year 2 and year 3.

Depletion is anaccrual accountingtechnique used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. The matching principle of accounting requires that amount of asset depleted in a given period must be expensed against the revenue in that period. Therefore, any method used for calculation of depletion expense must strictly obey the relevant accounting principles. Both royalty and working interests may use one of two types of depletion, cost and percentage, to determine which method yields the greater depletion deduction. The depletion should be reported on the Schedule E for royalty interest and on Schedule C for working interest as an expense. Generally, you must use the method that gives you the larger deduction. However, unless you are an independent producer or royalty owner, you generally cannot use percentage depletion for oil and gas wells.

Percentage depletion is calculated based on a percentage of gross income from the property. Percentage depletion can only be taken by a property that has net income. If a property has a net loss, percentage depletion cannot be deducted in the current year. It is VERY important to pay attention to the definition of net income in this scenario. Natural resources such as timber, oil and minerals require excavation from their sources in order for a company to make them into useful products. The entire process requires an allocation of money, which is called depletion. Learning depletion in accounting can equip you with skills such as performing accurate value identification of a resource and recording costs in balance sheets.


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