Depletion Method

Depletion Method Overview

Depletion is a periodic charge to expense for the use of natural resources. Thus, it is used in situations
where a company has recorded an asset for such items as oil reserves, coal deposits, or gravel pits.
The calculation of depletion involves these steps:
1.

Compute a depletion base

2.

Compute a unit depletion rate

3.

Charge depletion based on units of usage

The resulting net carrying amount of natural resources still on the books of a business do not
necessarily reflect the market value of the underlying natural resources. Rather, the amount simplify
reflects an ongoing reduction in the amount of the original recorded cost of the natural resources.
The depletion base is the asset that is to be depleted. It is comprised of the following four types of
costs:

Acquisition costs. The cost to either buy or lease property.

Exploration costs. The cost to locate assets that may then be depleted. In most cases, these
costs are charged to expense as incurred.

Development costs. The cost to prepare the property for asset extraction, which includes the
cost of such items as tunnels and wells.

Restoration costs. The cost to restore property to its original condition after depletion activities
have been concluded.
To compute a unit depletion rate, subtract the salvage value of the asset from the depletion base and
divide it by the total number of measurement units that you expect to recover. The formula for the
unit depletion rate is:
Depletion base - Salvage value
Total units to be recovered
You then create the depletion charge based on actual units of usage. 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.

The estimated amount of a natural resource that can be recovered will change constantly as you
gradually extract assets from a property. As you revise your estimates of the remaining amount of
extractable natural resource, you should incorporate these estimates into the unit depletion rate for
the remaining amount to be extracted. This is not a retrospective calculation.
Depletion Method Example
Pensive Corporations subsidiary Pensive Oil drills a well with the intention of extracting oil from a
known reservoir. It incurs the following costs related to the acquisition of property and development of
the site:
Land purchase

$280,000

Road construction

23,000

Drill pad construction

48,000

Drilling fees
Total

192,000
$543,000

In addition, Pensive Oil estimates that it will incur a site restoration cost of $57,000 once extraction is
complete, so the total depletion base of the property is $600,000.
Pensives geologists estimate that the proven oil reserves that are accessed by the well are 400,000
barrels, so the unit depletion charge will be $1.50 per barrel of oil extracted ($600,000 depletion
base / 400,000 barrels).
In the first year, Pensive Oil extracts 100,000 barrels of oil from the well, which results in a depletion
charge of $150,000 (100,000 barrels x $1.50 unit depletion charge).
At the beginning of the second year of operations, Pensives geologists issue a revised estimate of the
remaining amount of proven reserves, with the new estimate of 280,000 barrels being 20,000 barrels
lower than the original estimate (less extractions already completed). This means that the unit
depletion charge will increase to $1.61 ($450,000 remaining depletion base / 280,000 barrels).
During the second year, Pensive Oil extracts 80,000 barrels of oil from the well, which results in a
depletion charge of $128,800 (80,000 barrels x $1.61 unit depletion charge).
At the end of the second year, there is still a depletion base of $321,200 that must be charged to
expense in proportion to the amount of any remaining extractions.