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Explain the concept of depletion in accounting.
Depletion is a non-cash expenses which lowers the value of the asset periodically, through scheduled charges. Process of converting existing goods to new one is called production process. Depletion tells about how much quantity is produced in production process. Generally, depletion is used in timber, mining and oil and gas industries.
Main factors that affect depletion are as follows −
- Acquisition − Acquiring or leasing the rights for a land.
- Exploration − Exploring the natural resources.
- Development − Developing more and more wells to get more output.
- Restoration − Expenses incurred to get back to its original conditions.
Types of depletion are explained below −
Percentage depletion − Fixed percentage is allocated to revenue. It is not reliable or is not commonly used, because it requires lot of estimations.
Percentage depletion = f (industry factors)
Cost depletion − It is based on quality of resource extracted to remaining.
Cost of depletion = ((unit sold in the current year) / (reserve in hand at the end of year+ unit sold in the current year)) * adjusted basis of the property at the end of the current year.
Cost of depletion = ((adjusted basis of the property at the end of the current year) / (reserve in hand at the end of year+ unit sold in the current year)) / (unit sold in the current year).
Steps involved are as follows −
- Compute depletion base.
- Compute unit depletion rate.
- Calculate depletion based on its usage.
Depletion rate = (depletion base – salvage value)/total units to be recovered
Depletion expenses = ((cost-salvage value)/estimated number of units))* number of units extracted
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