I'm Larry Walther, this is principlesofaccounting.com, Chapter 11.
In this module we will consider natural resource accounting and
the related depletion charges.
Now, natural resources are things that come from the earth,
examples include oil and gas reserves, mineral deposits,
thermal energy sources, timber, things of this nature.
These assets should initially be recorded at their direct cost of acquisition,
plus related items like legal fees, surveying costs, exploration, and
development costs potentially.
So there is a host of costs that might be captured in the cost pool for
a particular natural resource.
That cost pool is allocated over the periods benefited
through a process known as depletion.
Essentially, depletion is to a natural resource as depreciation is to property,
plant, and equipment.
Let's look at depletion in calculations.
The cost of the natural resource, less any expected residual value,
should be divided by the estimated units in the resource pool of the resource base.
This results in an amount of depletion per unit,
we'll look at an example here in just a moment.
If during a particular period all of the resources that are extracted
are also sold or disposed of, then the depletion expense for the period would
correspond to the depletion per unit times the number of units extracted and sold.
However, if a portion of the extracted resources remain unsold at the end of
the period, those costs should be carried on the balance sheet as inventory.
So let's look at an example.
Here we have a mine site, it was purchased for $9 million and an additional $3
million was spent on development cost and preparing the site for production.
The site is estimated it contained 5 million tons of the targeted ore.
And at completion of the operation the site is going to be water flooded and
turned into a reservoir that we expect to be able to sell for $2 million.
So taking those facts into account, we have a $9 million initial cost
plus the $3 million development cost less the $2 million estimated residual
value to arrive at the depletable base of $10 million divided by the 5
million tons gives us an expected depletion charge of $2 per ton.
Continuing, assume that during a particular period,
1 million tons of the ore are extracted.
That million tons would be assigned a cost of $2 million.
Again, that's the $2 per unit times the million tons that were extracted.
So our total depletion charge is 2 million, furthering our discussion though,
if 750,000 of those tons are sold and the other 250,000 tons
are simply held in inventory, then what we would have
is $1,500,000 of the depletion charge that would be assigned to cost of good sold.
That is $2 per ton times 750,000 tons extracted and sold.
The other 250,000 tons that we keep in inventory would be assigned their $2 per
unit cost and we would have 500,000 that would be reported in the balance sheet.
So here's a journal entry for depletion for this particular period.
Here I'm crediting the natural resource $2 million, or
alternatively I could have simply credited accumulated depletion
more likely just crediting the natural resource in this case.
500,000 of that cost is allocated or debited to inventory.
And 1,500,000 Winds up in the cost of goods sold account.
So let's look further now, thinking about property, plant, and equipment
assets that are used in connection with the extraction of natural resources.
Obviously, we're gonna need bulldozers, and cranes, and mining equipment, and
things of that nature.
So we need to consider what we'd do with those particular assets.
Those assets will not be depleted,
they will be depreciated along with our other property, plant, and equipment.
The depreciation period should be over the useful life of the asset.
And sometimes the useful life of the asset is tied directly to the natural resource
life, even though its actual physical life might be longer.
Let's imagine a train track that we built down into a mine
that we dig into the earth.
Well, the train track might have a 100 year useful life, but
if the mine's only gonna operate we would depreciate that track over 20 years.
On the other hand,
if it was the rail car that runs on that track that has say a 50 year life,
after 20 years we could move it to another mine or sell it, something of that nature.
We would probably use the longer useful life to depreciate that
train car that would run on the track.