How do depletion and depreciation methods differ

I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Depreciation relates to the cost of a tangible asset, depletion to the cost of extracting natural resources, and amortization to the deduction of an intangible asset.

The use of all three expensing strategies is typically associated with the acquisition, exploration, and development of new oil and natural gas reserves. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.

Related Terms Amortization Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. Straight Line Basis Definition Straight line basis is the simplest method of calculating depreciation and amortization, the process of expensing an asset over a specific period.

Depletion Definition Depletion is an accrual accounting method used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. Capitalization Definition Capitalization is an accounting method in which a cost is included in the value of an asset and expensed over the useful life of that asset. Until now, we have assumed a definite physical or economically functional useful life for the depreciable assets.

However, in some situations, depreciable assets can be used beyond their useful life. If so desired, the company could continue to use the asset beyond the original estimated economic life. In this case, a new remaining depreciation expense would be calculated based on the remaining depreciable base and estimated remaining economic life. As with the straight-line example, the asset could be used for more than five years, with depreciation recalculated at the end of year five using the double-declining balance method.

As a side note, there often is a difference in useful lives for assets when following GAAP versus the guidelines for depreciation under federal tax law, as enforced by the Internal Revenue Service IRS. This difference is not unexpected when you consider that tax law is typically determined by the United States Congress, and there often is an economic reason for tax policy. For example, if we want to increase investment in real estate, shortening the economic lives of real estate for taxation calculations can have a positive increasing effect on new construction.

If we want to slow down new production, extending the economic life can have the desired slowing effect. In this course, we concentrate on financial accounting depreciation principles rather than tax depreciation. Another type of fixed asset is natural resources , assets a company owns that are consumed when used.

These assets are considered natural resources while they are still part of the land; as they are extracted from the land and converted into products, they are then accounted for as inventory raw materials. As the resource is consumed converted to a product , the cost of the asset must be expensed: this process is called depletion.

As with depreciation of nonnatural resource assets, a contra account called accumulated depletion , which records the total depletion expense for a natural resource over its life, offsets the natural resource asset account. Depletion expense is typically calculated based on the number of units extracted from cutting, mining, or pumping the resource from the land, similar to the units-of-production method.

For example, assume a company has an oil well with an estimated 10, gallons of crude oil. Recall that intangible assets are recorded as long-term assets at their cost. As with tangible assets, many intangible assets have a finite limited life span so their costs must be allocated over their useful lives: this process is amortization.

Depreciation and amortization are similar in nature but have some important differences. First, amortization is typically only done using the straight-line method. Second, there is usually no salvage value for intangible assets because they are completely used up over their life span. Finally, an accumulated amortization account is not required to record yearly expenses as is needed with depreciation ; instead, the intangible asset account is written down each period.

Assuming that it was placed into service on October 1, , the journal entry would be as follows:. Figure Define natural resources. Figure Explain the difference between depreciation, depletion, and amortization. Depreciation is the process of allocating the cost of using a long-term asset over its anticipated economic useful life, whereas depletion is the process of expensing the cost of natural resources over the life of the asset, typically using a unit-consumed method.

Amortization is specifically for intangible assets and typically is calculated using straight-line with no salvage value. Figure Montello Inc. Montello uses the straight-line depreciation method. Calculate the annual depreciation expense. Montello uses the units-of-production depreciation method and in year one it expects to use the truck for 23, miles. Figure Steele Corp. Regarding the purchase, Steele recorded the following transactions:. Figure Calico Inc.

The patent has a life of twenty years, but Calico only expects to be able to sell the drug for fifteen years. Calculate the amortization expense and record the journal for the first-year expense. Although this printer is expected to last for ten years, Alfredo knows the technology will become old quickly, and so they plan to replace this printer in three years. Calculate yearly depreciation using the double-declining-balance method. Figure Using the information from Figure , calculate depreciation using the straight-line method.

Figure Santa Rosa recently purchased a new boat to help ship product overseas. The following information is related to that purchase:. Determine the acquisition cost of the boat, and record the journal entry needed. Figure Warriors Productions recently purchased a copyright. Although the copyright is expected to last a minimum of twenty-five years, the chief executive officer of the company believes this B-list movie will only be useful for the next fifteen years. Montello uses the units-of-production depreciation method, and in year one it expects to use the truck for 26, miles.

Regarding the purchase, Steele. The patent has a life of twenty years, but Calico expects to be able to sell the drug for fifty years. Although this printer is expected to last for ten years, Kenzie knows the technology will become old quickly and so she plans to replace this printer in three years. Figure Ronson recently purchased a new boat to help ship product overseas. Determine the acquisition cost of the boat and record the journal entry needed.

Under both of these methods depreciation expense will start out higher than straight line and will decline over time. Different formulas are used to calculate depreciation expense under each of them and generally SYD will have a "gentler slope" than DDB. In other words, SYD depreciation expense will not be as high as DDB depreciation at the beginning of an asset's life and will decline more gradually. I have no idea what the purpose of SYD is, other than to torture accounting students.

This is the declining balance as accumulated depreciation increases, book-value becomes smaller If the useful life is ten years:. 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.