Natural resources, such as minerals, oil, and timber, are long-lived assets that are extracted from the earth. Depletion is the accounting measure used to allocate the acquisition cost of these resources. It differs from depreciation in that it specifically focuses on the physical use and exhaustion of the natural resources, while depreciation focuses on any reduction in the economic value of a plant or fixed asset.
Depletion expense is the measure of the portion of long-term assets that is used up in a given period. To calculate depletion expense, a company must first determine the depletion rate, which is the percentage of the resource that is expected to be extracted in a given period. The depletion rate is calculated by dividing the total estimated recoverable resources by the total acquisition cost of the resource.
For example, if the company extracts 50,000 grams of gold in a given period, the depletion expense for that period would be calculated as follows: Depletion expense = Depletion rate * Production * Acquisition cost = 0.05 grams per dollar * 50,000 grams * $10,000,000 = $250,000 This depletion expense would be recorded as a debit to the depletion expense account and a credit to the natural resource account.
It is important to note that depletion is only applicable to natural resources that are extracted and sold in their physical form, such as gold, oil, and timber. Natural resources that are not extracted, such as land, or that are extracted and then processed into a different form, such as refining oil into gasoline, are not eligible for depletion. These natural resources are typically recorded as long-term assets and depreciated over their useful lives.