It is a systematic reduction in the value of a natural resource as an asset. In accounting, depletion is mainly associated with the extraction of natural resources i.e. mineral assets. For example – extraction of coal from a mine, extraction of limestone from a quarry, unearthing oil from an oil well, etc. The cost of extracting the mineral is spread between the number of years the natural reserve is expected to last.
For instance, if an oil well is anticipated to last for 20 years and the predicted benefits are worth 20,000,000 (20 Million) then the depletion amount (assuming uniform extraction) would be 1,000,000 (1 Million) each year. It is different from depreciation & amortization, however, the fundamental logic of the application is similar.
Such assets are commonly termed as wasting assets since they are eventually used up and will have no remaining value.
Depletion Accounting – It is a form of applying depreciation on such wasting assets, the percentage to be applied is calculated based on the rate at which the natural resource is being used. For example, an oil well would be depreciated based on the rate at which the oil is being extracted from it.
Related Topic – Depreciation Vs Depletion Vs Amortization
Continuous improvement, innovation, market trends, etc. in the market lead to the production of new and improved assets. It causes a reduction in the monetary value of assets which are currently being used. This whole process of an asset becoming out of date and losing its economic value is called Obsolescence.
The concept of obsolescence is useful while applying depreciation or evaluating stock (inventory). A fixed asset may become obsolete even before the end of its predicted useful life. While evaluating inventory all obsolete (outdated) items are supposed to be charged to the Income statement.
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