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How Do You Calculate Depletion?

Published in Depletion Calculation 3 mins read

You calculate depletion by first determining the depletion rate per unit and then multiplying that rate by the number of units extracted during a period. Here's a breakdown:

Steps to Calculate Depletion:

  1. Determine the Depletion Base: This is the cost of the natural resource property. It includes the acquisition cost, exploration costs, and development costs.

  2. Determine the Salvage Value (if any): This is the estimated value of the land after the natural resource has been completely extracted. If the land has no value after extraction, the salvage value is zero.

  3. Calculate the Depletion Rate per Unit: Use the following formula:

    (Depletion Base – Salvage Value) ÷ Total Estimated Units Recoverable = Depletion Rate per Unit

    • Depletion Base: The total cost associated with acquiring and preparing the resource for extraction.
    • Salvage Value: The estimated value of the land after the resource is exhausted.
    • Total Estimated Units Recoverable: The total amount of the natural resource that is estimated to be extracted from the property.

  4. Calculate the Depletion Charge for the Period: Use the following formula:

    Units Extracted within Period x Depletion Rate per Unit = Depletion Charge for Period

    • Units Extracted within Period: The number of units (e.g., tons of coal, barrels of oil) extracted during the accounting period.
    • Depletion Rate per Unit: As calculated in Step 3.

Example:

Let's say a company purchases a mine for \$1,000,000. They estimate that 200,000 tons of ore can be extracted from the mine. The land will have a salvage value of \$100,000 after the ore is extracted. During the first year, the company extracts 40,000 tons of ore.

  1. Depletion Base: \$1,000,000
  2. Salvage Value: \$100,000
  3. Total Estimated Units Recoverable: 200,000 tons

Calculating the Depletion Rate per Unit:

(\$1,000,000 - \$100,000) ÷ 200,000 tons = \$4.50 per ton

Calculating the Depletion Charge for the First Year:

40,000 tons x \$4.50 per ton = \$180,000

Therefore, the depletion expense for the first year is \$180,000. This amount is expensed on the income statement, and the accumulated depletion is increased on the balance sheet.

Important Considerations:

  • Estimates: The "Total Estimated Units Recoverable" is an estimate, and it may need to be revised as new information becomes available. Any revision to the estimate will change the depletion rate prospectively (going forward).

  • Units Sold vs. Units Extracted: Depletion expense is generally based on units extracted. However, if all units extracted are not sold, depletion expense should be calculated only on units sold.

  • Tax Implications: Depletion is deductible for tax purposes. Companies can generally deduct either cost depletion (calculated as described above) or percentage depletion, whichever is greater (subject to certain limitations). Percentage depletion is a percentage of gross income from the property.

In summary, calculating depletion involves determining the cost basis of the resource, estimating the recoverable units, and then allocating the cost over the units extracted each period.

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