Depletion (accounting)

Depletion is an accounting concept used most often in mining, timber, petroleum, or other similar industries. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves. Depletion is similar to depreciation in that it is a cost recovery system for accounting and tax reporting. For tax purposes, the two types of depletion are cost depletion and percentage depletion.

For mineral property, one generally must use the method that gives you the larger deduction. For standing timber, one must use cost depletion.

According to the IRS Newswire, over 50 percent of oil and gas extraction businesses use cost depletion to figure their depletion deduction. Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). For that purpose, property is each separate interest businesses own in each mineral deposit in each separate tract or parcel of land. Businesses can treat two or more separate interests as one property or as separate properties.

Depletion, for both accounting purposes and United States tax purposes, is a method of recording the gradual expense or use of natural resources over time. Depletion is the using up of natural resources by mining, quarrying, drilling, or felling.

To figure percentage depletion, one multiplies a certain percentage, specified for each mineral, by gross income from the property during the tax year. The rates to be used and other conditions and qualifications for oil and gas wells are discussed below under Independent Producers and Royalty Owners and under Natural Gas Wells. Rates and other rules for percentage depletion of other specific minerals are found later in Mines and Geothermal Deposits.

Cost depletion is an accounting method by which costs of natural resources are allocated to depletion over the period that make up the life of the asset. Cost depletion is computed by estimating the total quantity of mineral or other resources acquired and assigning a proportionate amount of the total resource cost to the quantity extracted in the period. For example, if Big Texas Oil, Co. discovers a large reserve of oil, the company has estimated the oil well will produce 200,000 barrels of oil. The company invests $100,000 to extract the oil and extracts 10,000 barrels the first year. Therefore, the depletion deduction is $5,000 ($100,000 X 10,000/200,000).

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