What is Depletion Expense?

Depletion expense is a charge against profits for the use of natural resources. The depletion concept is most commonly used in the mining, timber, and oil and gas industries, where exploration and development costs are capitalized, and depletion is needed as a logical system for charging these costs to expense.

How to Calculate Depletion Expense

The calculation of depletion expense is to multiply the number of consumed units of the natural resource by the cost per unit. The cost per unit is derived by aggregating the total cost to purchase, explore for, and develop the natural resource, divided by the total number of units expected to be extracted.

Example of Depletion Expense

A coal mining firm has purchased mineral rights for $10,000,000 and spent an additional $2,000,000 to develop the property. The firm expects to extract 500,000 tons of coal. Based on this information, the depletion rate will be $12,000,000 divided by 500,000 tons, or $24 per ton. In the most recent period, the company extracted 1,000 tons, for which the related depletion expense is $24,000.

Depletion Expense vs. Depreciation Expense

Depletion expense is a charge against profits for the use of natural resources. This concept differs from depreciation, where the calculation is based on a fixed usage period. There are several significant differences between the concepts, which are as follows:

Nature of the asset. Depletion expense applies to natural resources, while depreciation expense applies to tangible fixed assets.
Basis of allocation. Depletion expense allocates the cost of a natural resource as it is physically consumed or extracted, while depreciation expense allocates the cost of a tangible fixed asset over its estimated useful life, irrespective of physical usage.
Method of calculation. Depletion expense calculates the expense based on the quantity of the resource extracted, while depreciation expense uses a time-based approach to calculate the expense.
Asset value. Depletion expense reduces the book value of the natural resource asset as the resource is extracted, while depreciation expense reduces the book value of the tangible fixed asset over time due to wear and tear, obsolescence, or usage.
Residual value. For depletion expense, residual value often represents the expected value of land after the resource is exhausted. For depreciation expense, residual value reflects the estimated salvage value of the tangible asset after its useful life.
Applicability. Depletion expense is primarily used by companies involved in industries like mining, oil and gas, or forestry, while depreciation expense is used across all industries with tangible fixed assets.
Accounting presentation. Depletion expense is typically shown as a separate line item under expenses related to cost of goods sold, while depreciation expense is often included in operating expenses.

In summary, depletion expense is focused on allocating the cost of natural resources as they are extracted, while depreciation expense allocates the cost of tangible assets over their useful life. Both serve to reflect the consumption of assets in financial statements but apply to fundamentally different types of assets.