It’s critical first to define a natural resource to comprehend this phrase completely. Natural resources include the environment’s reserves of minerals, gas, and oil. Natural resources may be employed in much the same way as other products that people utilize. However, their utilization involves taking them out of the natural environment or extracting them.
The term “depletion” refers to an accrual accounting method frequently employed in businesses that extract natural resources, like mining, petroleum, and the forestry industry.
An accumulated depletion is a long-term decline in an asset’s value completely. The physical deterioration of an asset’s characteristics leads to accumulated depletion. As an illustration, an oil field has a finite amount of oil. As oil is dug up over time, the value of the oil field is completely diminished. This is known as accumulated depletion. Natural resource assets are those where accumulated depletion is most frequently documented on a balance sheet.
Depletion and depreciation function as cost recovery systems for tax reporting and accounting, making them comparable. An individual can use the depletion deduction to account for the decline in product reserves.
You may divide the costs among several eras based on the harvested resource once you’ve capitalized the costs associated with extracting natural resources. These expenses are typically kept on the balance sheet until the expenditure recognition occurs.
There are two depletion techniques used for tax purposes. Cost and proportion are among them.
Method of Percentage Depletion
The percentage approach is one of the various techniques used to determine costs associated with depletion. It operates by allocating costs according to a defined percentage of gross income. This approach makes extensive use of estimations. It is not relied upon as a result.
Method of Cost Depletion
Another way to determine depletion is by cost depletion. You can use this accounting approach by allocating the expenses of natural resources to depletion throughout the asset’s life. It would help if you had the property basis, recoverable unit total, and accounting number of units sold to figure out cost depletion. Natural resources are counted and subtracted from the base of the property when you extract them.
Accumulated Depletion Calculated
= Production Investment Amount X Amount of Product Produced / Total Production Lifetime
If a corporation spends $1,000 to chop wood and produces 2000 quintals of lumber overall, but only 50 quintals of timber in the first year, then the depletion value is thus $1000 X 50 / 2000 = 25 dollars.
If the balance sheet’s liability side instead of the asset side shows the depletion. This is then referred to as cumulative depletion.
The amount of depletion expenditure accumulated over time in connection to the utilization of a natural resource is known as accrued depletion. On the balance sheet, this sum is listed as a counter account beside the asset representing natural resources. This combination has the overall result of showing fewer natural resource assets on the balance sheet. For example, a mine is a typically natural resource linked to depletion.
The linked mine’s useful life is undoubtedly nearing its conclusion if a company reports a significant quantity of cumulative depletion in comparison to the amount of natural resources assets on its books.