Depletion is an accounting process that allocates the cost of extracting natural resources, such as oil, metals or timber, as each unit of natural resource is extracted and sold. Depletion expense is the amount of depletion a company reports on its income statement for a particular accounting period for financial reporting purposes. Depletion is similar to the depreciation of a long-lived asset because the up-front cost to acquire an asset is expensed over time, rather than all at once. You can calculate depletion expense for an accounting period using the units-of-activity method.
Determine the cost to acquire a natural resource, the costs to prepare the property for extraction and restore it after extraction, the expected residual value after the resource has been extracted and the number of units the natural resource contains.
Add the acquisition cost of the natural resource to the preparation and restoration costs of the resource and subtract the residual value to calculate the depletable base. For example, add a $1 million acquisition cost to purchase an oil field to $1 million in development and restoration costs to prepare the field and restore it, and subtract a $100,000 residual value. This equals a $1.9 million depletable base.
Divide the depletable base by the number of units the natural resource contains to determine the per-unit depletion expense. For example, divide a $1.9 million depletable base by 40,000 barrels of oil. This equals a $47.50 depletion expense per unit.
Determine the number of units of the natural resource extracted and sold during an accounting period.
Multiply the number of units extracted and sold by the per-unit depletion expense to determine the depletion expense for the accounting period. For example, multiply 10,000 barrels of oil extracted and sold by $47.50. This equals $475,000 in depletion expenses for the accounting period.