Depletion
Candlefocus EditorThere are two main types of depletion accounting methods - percentage depletion and cost depletion. Under percentage depletion, a fixed percentage of the cost of the extracted asset is subtracted from taxable income each year, up to a specified amount. This type of depletion method is usually used for extracting oil and gas, among other resources. Cost depletion, on the other hand, involves allocating the cost of extracting resources in a periodical basis and depreciating the resource over time.
Depletion is an important accounting concept, as it helps to properly recognize the depletion of natural resources by businesses. As such, it helps to ensure that any costs associated with these resources are cost-effectively spread across time periods as resources are extracted, and that depletion does not take place faster than depletion income is being generated. It also helps to deflect any bonus payments from the owner of a natural resource to the public.
The depletion of a natural resource may be determined using a depletion rate. This rate can be expressed as the cost of depleting the natural resource per unit of resources extracted. When using percentage depletion, the depletion rate is calculated based on the ownership costs for resources extracted, such as land value, tax assessments and royalties, while for cost depletion the rate is calculated by dividing the total ownership costs by the expected total number of units of resources to be extracted.
In conclusion, as a form of accrual-based accounting, depletion accounting helps to ensure that the cost of exploiting natural resources is allocated over time in an efficient and fair manner. Companies are able to account for the depletion of resources in a manner that benefits both businesses and the public. It also helps to provide a more accurate reflection of their incomes and taxes due in order to properly invest in new resources and avoid over-exploitation.