The property’s basis is distributed among the total number of recoverable units. As natural resources are extracted, they are counted and taken out from the property’s basis. The estimated amount of a natural resource that can be recovered will change constantly as assets are gradually extracted from a property. As you revise your estimates of the remaining amount of extractable natural resource, incorporate these estimates into the unit depletion rate for the remaining amount to be extracted. Thus, if you extract 500 barrels of oil and the unit depletion rate is $5.00 per barrel, then you charge $2,500 to depletion expense.
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The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. There are three steps involved in computation of depreciation under depletion method. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.
The Difference Between Cost Depletion and Percentage Depletion
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. Cost depletion is typically part of the “DD&A” (depletion, depreciation, and amortization) line of a natural resource company’s income statement. Depletion is similar to depreciation, which is used to allocate the cost of tangible assets like factories and equipment over their useful lives. Depletion is used for natural resources, which can include minerals, ore, oil, gas, and timber.
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Depletion is the process by which natural resources lose their benefits as they are removed. It follows the same process used in Depreciation, which is an accounting technique used to allocate the cost of tangible assets over their useful lives. This means the unit depletion charge will increase to $1.61 ($450,000 remaining depletion base / 280,000 barrels). This means that the unit depletion charge will increase to $1.61 ($450,000 remaining depletion base / 280,000 barrels).
- As a general rule, investors have to use the method that provides the largest deduction.
- If a company has $5 million in gross income from a resource and wants to use a 15% depletion rate over a given period, its depletion deduction would amount to $750,000 million.
- For example, if $10 million of oil is extracted and the fixed percentage is 15%, $1.5 million of capitalized costs to extract the natural resource are depleted.
- One method of calculating depletion expense is the percentage depletion method.
- As you revise your estimates of the remaining amount of extractable natural resource, incorporate these estimates into the unit depletion rate for the remaining amount to be extracted.
There are a number of different methods that can be used to account for depletion. The most common method is the straight-line Depreciation method, which allocates the depletion expense evenly over the estimated economic life of the natural resource. Other methods include the units-of-production method and the percent-of-revenue method. This calculation results in a depletion expense per unit that is charged against the revenue generated from the natural resource. The other method of depletion is percentage depletion, which is calculated by multiplying the gross income received in the tax year from extracting a resource by an IRS-determined percentage established for each resource.
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More than one person (or company) can have an economic interest in a mineral deposit or timber land. The IRS defines an economic interest as having any interest in mineral deposits or standing timber and a legal right to income from mineral extraction or timber harvesting. Cost depletion (which is required under GAAP) should not be confused with percentage depletion deductions allowed by the income tax laws. Founded in 1993, The Motley Fool is a financial services company dedicated to making the world smarter, happier, and richer.
The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. While the numerator (units produced in the period) is usually reliably measurable, minimum level of stock explanation formula example the denominator (units available from the property) is often impossible to measure precisely. Watch this video for an overview of these terms each of which will be examined further. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.
Double-declining-balance method To apply the double-declining-balance (DDB) method of computing periodic depreciation charges you begin by calculating the straight-line depreciation rate. To do this, divide 100 per cent by the number of years of useful life of the asset. Next, apply the resulting double-declining rate to the declining book value of the asset.
