Accounting for Natural Resource Assets & Depletion

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  • 0:02 Natural Resource Assets
  • 0:38 Depreciation and Depletion
  • 1:33 Accounting for Depletion
  • 1:59 Steps to Compute Depletion
  • 5:53 Lesson Summary
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Lesson Transcript
Instructor: Anthony Aparicio

Tony taught Business and Aeronautics courses for eight years; he holds a Master's degree in Management and is completing a PhD in Organizational Psychology

Many companies are in the business of mining natural resources from the earth. How does a company account for the value of the land as those assets are removed? This lesson will describe the accounting procedure called depletion.

Natural Resource Assets

You should be familiar with the definition of an asset in a company and how to account for them on the balance sheet. However, you may not know how an asset such as land with minerals is handled in accounting. For this lesson, we will travel with Lydia, who is the owner of Profits, Inc., as she goes into the business of purchasing land and selling the natural resources.

For her first purchase, Lydia finds a plot of land that consists of 1,000 acres and is estimated to contain 600,000 tons of coal. She purchases the land through her company for a price of $300,000.

Depreciation and Depletion

When a company purchases a piece of machinery, the value of the machine decreases as it is used until it eventually reaches its salvage value. The salvage value is what the item is worth at the end of its useful life. The process of decreasing the value of equipment is called depreciation. Accepted accounting procedures allow many methods of depreciation, such as the straight-line method, the double-declining method, and the sum of years' method.

When the asset happens to involve land with an estimated amount of natural resources, the same concept of depreciation applies but in this case, it is called depletion because the resources are being depleted (removed) from the land. Depletion is also different because it does not depend on any length of time but is directly related to the amount of resources removed. Depletion would be used when resources such as coal, precious metals, timber, or petroleum are to be extracted.

Accounting for Depletion

When the land was purchased on October 11 by Profits, Inc., the accountants created and debited the Land account for $300,000 and credited the Cash account for the same amount. At the end of the year, Profits, Inc. removed 100,000 tons of coal from the land. Lydia knows that the land is not worth the same amount now as when she purchased it, but she needs to figure out how much it is worth as she begins to prepare her taxes.

Steps to Compute Depletion

Lydia knows she must follow three steps to make her calculations:

  1. She must divide the amount paid for the land by the estimated units of measure of the natural resource (in Lydia's case, tons)
  2. The result of that computation will give you the price for each unit of measure (the price per ton for Lydia)
  3. She must multiply the number of units of measure extracted by the cost for each unit

In this case Lydia, would divide the $300,000 she paid for the land by 600,000 tons of estimated coal to come up with $.50 per ton. She would now multiply the $.50 per ton times the number of tons removed (100,000) to come up with a depletion amount of $50,000.

Lydia can now update the value of her land by debiting the Depletion Expense account and credit the Accumulated Depletion - Land account. The Accumulated Depletion - Land account is considered a contra-asset account and will offset the asset 'Land' on her balance sheet. A contra-asset account typically has a credit balance and is attached to an asset to give it its current value. Note that the asset account itself (Land) still has a debit balance of $300,000, but its true value can only be found when taking the contra-asset account into consideration, as well. The real value of the Land account is the $300,000 minus its associated Accumulated Depletion account of $50,000 for an end-of-year value of $250,000.

Additional Examples

Here's a question for you: What is the value of the land Lydia purchased at the end of the second year after her company has removed another 250,000 tons of coal?

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