Corporate Finance & Accounting

consume

What is exhaustion?

Consumption is an accrual accounting technique used to allocate the cost of extracting natural resources such as wood, minerals and oil from the earth.

Like depreciation and amortization, depletion is a non-cash expense Progressively reduce the cost value of an asset through predetermined revenue charges. Depletion differs in that it refers to the gradual depletion of natural resource reserves rather than the wear and tear of depreciable assets or the aging of intangible assets.

How depletion works

Depletion for accounting and financial reporting purposes is designed to help accurately identify the value of an asset on the balance sheet and record the expense within the appropriate time period on the income statement.

When the costs associated with the extraction of natural resources have been capitalized, the fees are allocated systematically over different time periods based on the resources extracted. Costs are retained on the balance sheet until expense recognition is incurred.

key takeaways

  • Consumption is an accrual accounting method used to allocate the cost of extracting natural resources such as wood, minerals and oil from the earth.
  • When the costs associated with the extraction of natural resources have been capitalized, the fees are allocated systematically over different time periods based on the resources extracted.
  • There are two basic forms of consumption perks: percentage consumption and cost consumption.

record exhaustion

In order to calculate the apportioned costs of using natural resources, each different stage of production must be taken into account. The consumption basis is the capitalized cost of consumption over multiple accounting periods. There are four main factors that affect the exhaustion base:

  • get: Costs associated with buying or leasing title to land that the company believes has natural resources.
  • exploration: Expenses associated with excavating under leased or purchased land.
  • developing: This The cost of preparing land for natural resource extraction, such as digging tunnels or developing water wells.
  • recover: Expenses associated with restoring the land to its original state upon completion.

percentage depletion

One way to calculate consumption costs is the consumption percentage method. It allocates a fixed percentage of total revenue (sales minus costs) to allocate expenses. For example, if $10 million of oil is extracted and the fixed percentage is 15%, the $1.5 million capitalized cost of extracting the natural resource will be exhausted.

The consumption percentage method requires a lot of estimation, so it is not a consumption method that is heavily relied upon or accepted.

cost consumption method

The second method of calculating consumption is the cost consumption method. Cost consumption is calculated by considering the property’s base, total recoverable reserves and the number of units sold. The basis of the property is distributed among the total number of recoverable units. As natural resources are extracted, they are calculated and taken from the foundation of the property.

For example, a capitalized cost of $1 million produces 500,000 barrels of oil. In the first year, if 100,000 barrels of oil are mined, the consumption for that period is $200,000 (100,000 barrels * ($1,000,000 / 500,000 barrels)

reporting requirements

The Internal Revenue Service (IRS) requires the use of a cost method for lumber.It requires that the method yielding the highest deduction be used for minerals, which it defines as oil and gas wells, mines and other natural deposits, including geothermal deposits.

Because the consumption percentage looks at the property’s gross income and taxable income limits, rather than the amount of natural resources mined, it is not an acceptable reporting method for some natural resources.

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