Ch 10 - Appendix B: Journalizing Adjusting Entries for Depletion

Plant assets and natural resources are tangible assets used by a company to produce revenues.  On the income statement, depreciation expense is recorded for plant assets and depletion expense is recorded for natural resources.  On the balance sheet, accumulated depreciation appears with the related plant asset account and accumulated depletion appears with the related natural resource account.

Remember, the adjusting entry for depreciation, regardless of the method used to calculate depreciation was:

Depreciation Expense  Debit    
    Accumulated Depreciation        Credit
For natural resources we will use Depletion Expense and Accumulated Depletion and the units of production method for calculating depletion.  The journal entry to record depletion would be similar to depreciation:

Depletion Expense  Debit  
    Accumulated Depletion   Credit
The previous video gave us a demonstration of the accounting process for depletion but we will review it here.

Computing periodic depletion cost To compute depletion charges, companies usually use the units-of-production method. They divide total cost by the estimated number of units—tons, barrels, or board feet—that can be economically extracted from the property. This calculation provides a per-unit depletion cost. For example, assume that in 2015 a company paid  $ 650,000 for a tract of land containing ore deposits. The company spent  $ 100,000 in exploration costs. The results indicated that approximately 900,000 tons of ore can be removed economically from the land, after which the land will be worth $50,000. The company incurred costs of $200,000 to develop the site, including the cost of running power lines and building roads. Total cost subject to depletion is the net cost assignable to the natural resource plus the exploration and development costs. When the property is purchased, a journal entry assigns the purchase price to the two assets purchased—the natural resource and the land. The entry would be:

 

Land 		Debit

50,000		 Credit

 
Ore Deposits 600,000  
Cash   650,000
To record purchase of land and mine.    
After the purchase, an entry debits all costs to develop the site (including exploration) to the natural resource account. The entry would be:

 

Ore Deposits ($100,000 + $200,000) 		Debit

300,000		  Credit

 
Cash   300,000
To record costs of exploration and development.    
Under the units of production method, we use a 2-step process:

  1. Calculate depletion cost per unit  (Cost - salvage or residual value) / total amount expected to be used over its lifetime
  2. Calculate depletion expense  (units used this period x depletion per unit)


In some instances, companies buy only the right to extract the natural resource from someone else’s land. When the land is not purchased, its residual value is irrelevant and should be ignored. If there is an obligation to restore the land to a usable condition, the firm adds these estimated restoration costs to the costs to develop the site.

In the example where the land was purchased, the total costs of the mineral deposits equal the cost of the site ($ 650,000) minus the residual value of land ($ 50,000) plus costs to develop the site ($ 300,000), or a total of  $900,000. The unit (per ton) depletion charge is $ 1 (or $ 900,000 cost /900,000 tons).   If 100,000 tons are mined in 2015, this entry records the depletion cost of  $100,000 ($1 depletion per unit  X 100,000 tons mined) for the period:

 

Depletion Expense		 Debit

100,000		  Credit

 
Accumulated Depletion—Ore Deposits   100,000
To record depletion for 2015.
 

http://www.openassessments.org/assessments/1195

Licenses and Attributions