How does depletion differ from depreciation

Both are used to reduce the asset value, as the asset is used over time. These are non-cash deductions from income, and they do not take time value of money into account. Depreciation is the accounting term used for assets such as buildings, furniture and fittings, equipment etc. Companies use this to record the diminishing value of their assets as they are used in the business from the time of purchase of such assets. Different methods exist in calculating the depreciation amount and these are different depending on the asset type.

The journal entry to be passed in the books is:. The depreciation is debited to the profit and loss account as an expense and accumulated depreciation is reported as reduction from the value of the fixed asset in the balance sheet.

Depletion is the allocation of the cost of acquiring natural resources over its estimated useful life. Several entities are engaged in the extraction of natural resources such as coal mines, oil reserves , mineral reserves etc. This requires incurrence of costs such as cost of acquiring rights in the resource, cost of preparing the resource for extraction etc.

Extraction from natural resources are expected to give benefits over several years and thus these costs are initially capitalized. The capitalized cost is subsequently allocated as expense as and when the resources are extracted and utilized.

This periodic charge to the profit and loss of the cost of the natural resource is termed as depletion. Natural resources, especially non-renewable resources are likely to have a limited output capability — for e. Depletion thus occurs due to the exhaustion of supply of the specific natural resource.

There may be instances, where the acquisition of the resource requires a restoration cost at the end of its useful life. In such cases the formula for depletion would be modified to include this restoration cost.

The accounting entry for depletion is similar to that of depreciation, with a charge to profit and loss account and accumulation in accumulated depletion account. Both depreciation and depletion are cost allocations and thus non-cash expenses as they do not impact the cash flow of the entity. These allocations however impact both the profitability and the balance sheet position of the entity.

When you calculate amortisation you must take care to keep the book value in balance. It should not be overstated, nor understated.

This is a method used for intangible assets. Thus it generates variable amortisation rates. Being difficult to quantify and express in accounting the exact participation of an intangible asset to the general revenue, IAS 38 recommends not using this method. The straight-line method is preferred instead. This leads to a cover of the asset from the purchase price up to 0 value, or the residual value. It involves the book value the initial purchase price , the useful life span calculated in years , and the residual value.

The formula that determines the annual amortisation amount is the following:. The method applies to indefinite life assets for example the broadcasting rights or goodwill. The amortisation cannot be applied as for finite assets. Thus, for the indefinite ones, there is an annual impairment test being implemented every year. When the asset proves to be impaired, you have to make a life span estimation. Then the indefinite life asset shall be amortised just like a finite intangible asset for the rest of its useful life span.

Unlike the first two indicators, depreciation and amortisation, which are applicable for all industries and businesses, depletion works only for the energy and natural-resources field gas, oil, coal. Depletion relates to the costs of extracting these natural resources.

You could consider it to be similar to depreciation in the case of fixed assets. Thus, the depletion expense refers to the moment when the respective resource is being sold or used.

Companies cannot get a clear view regarding the exact amount of resources underground. Thus, the research, initial purchase, extraction, and further development costs are the ones capitalised for the natural resources, along the entire period they are being used.

Due to the particularities of operating with natural resources, companies cannot use the same methods as for depreciation.