Question

difine deplition and compare it with depreciation

Answer 1

Answer to Part - 1

Meaning of Depletion:

Depletion means gradual decrease in the natural resources of the company. It helps in the allocation of costs of extracting the natural resources i.e. oil, minerals, mines etc.

It is a non cash expense just like depreciation.

Impact on Financial Statements:

The total cost of extracting the natural resources is capitalized in the Balance Sheet and the same is moved over certain period in the profit and loss account in the name of depletion.

Methods of Depletion:

a) Cost Depletion Method:

In this method the per unit capitalized cost is multiplied by the actual extracted quantity.

In simple words we can say that the total cost is divided into total number of recoverable units.

Let us understand this by taking an example Let the total cost be $10 million and total extraction of natural resources would be 50,00,000 ton of coal. Per unit cost to be allocated is $ 2 ($10 Million / 50,00,000 ton). In 1st year 10,00,000 ton has been extracted so the total depletion expense would be $20,00,000 (10,00,000*$2).

b) Percentage Depletion Method:

In this method a fixed percentage is assigned to the revenue(gross). The Gross revenue is computed by using the following formula = Sales – total cost.

Let us take an example to understand this method, Let the gross revenue is $50 Million and the fixed percentage is 10% then in each year $5 Million will be depleted.

This method requires lot of estimation.

Answer to Part-2

Comparison of Depletion and Depreciation

As discussed earlier depletion is of natural resources (i.e. the resources that cannot be renewed) however the depreciation is systematic allocation of tangible fixed assets over its useful life.

Depreciation is due to the normal wear and tear, passage of time and obsolesce, and change in the technology however the depletion is permanent reduction of the company’s resources.

They both have similar concepts (i.e. both decreases the value of the assets) however both are used for different type of asset.

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