Depletion Expense

Depletion is an accounting concept which is similar to depreciation but it is mostly used in timber, mining and mineral oil extraction industries to refer to the gradual exhaustion of natural resource deposits such as coal mines, oil fields, etc. Unlike depreciable assets, natural resources do not wear out (i.e. depreciate) with passage of time but they actually loose value when the resource is being extracted. Therefore we differentiate between depletion and depreciation.

The matching principle of accounting requires that amount of asset depleted in a given period must be expensed against the revenue in that period. Therefore, any method used for calculation of depletion expense must strictly obey the relevant accounting principles.

Formula

Assuming a company sells all of the natural resource extracted within a given period, the formula to calculate depletion expense for the period will be:

Depletion Expense = Cost − Salvage Value× Number of Units Extracted
Estimated Number of Units

The cost of a natural resource includes developmental costs. Subtracting estimated salvage value (if any) from the cost gives us the depletable cost which is then divided by estimated number of units to obtain cost per unit of natural resource. Multiplying cost per unit by number of units extracted during the period gives us the depletion expense for the period. This method to calculate depletion expense is similar to the units of production method of depreciation.

However, if a company does not sell all of the resource extracted in a given period, the calculation process needs to be modified so as to record any unsold amount as inventory and not as depletion expense. This is explained using the following example:

Example

A mining company purchased a coal mine on Jan 1 20X5 for $2,800,000. The estimated capacity of the mine is 1,750,000 tons of coal and the estimated salvage value is zero. The company incurred additional $50,000 on development of mine for extraction purposes. They had extracted 210,000 tons of coal from the mine up to Jan 31, 20X5 and sold all but 13,000 tons of the coal extracted from the mine, with in Jan 20X5. Calculate the depletion expense on the mine for the month ending Jan 31, 20X5.

Solution

Cost per Ton = 2,800,000 + 50,000 − 0
1,750,000
Cost per Ton = $1.62857
Total Depletion of Mine = $1.62857 × 210,000 = $342,000
Total Depletion of Mine = $342,000

So the mine will be stated at $2,558,000 (=2,800+50−342) in balance sheet on Jan 31, 20X5 but not all of the amount $342,000 will be recorded as depletion expense because the company had 13,000 ton of coal unsold at the end of the month. Here, the depletion expense will be calculated using the following formula:

Depletion Expense = Total Depletion of Mine − Depletion Related to Unsold Extract
Depletion Expense = $342,000 − $1.62857 × 14,000
Depletion Expense = $342,000 − $22,800
Depletion Expense = $319,200

The following journal entry records the depletion expense and inventory on Jan 31, 20X5:

Coal Inventory22,800
Depletion Expense319,200
Coal Mine Assets342,000

Written by Irfanullah Jan