In that case, it may gradually distribute to stockholders its capital investments by paying liquidating dividends, which are dividends greater than the amount of accumulated net income. This problem is the same as accounting for changes in estimates for the useful lives of plants and equipment. Tangible equipment costs include all the transportation and other heavy equipment needed to extract the resource and prepare it for the market. The systematic allocation of the cost of a tangible fixed asset over its useful life. Explanations may also be supplied in the footnotes, particularly if there is a large swing in the depreciation, depletion, and amortization (DD&A) charge from one period to the next. This controversy in the oil and gas industry provides a number of lessons.
Depletion: Definition, 4 Affecting Factors, and Depletion Methods
If all of the resource is sold, we expense all of the depletion and removal costs. Depletion is the exhaustion that results from the physical removal of a part of a natural resource. For example; removing copper through mining or cutting timber for a paper company. In each accounting period, the depletion recognized is an estimate of the cost of the natural resource that was removed from its natural setting during the period.
Restoration Costs
For example, if $10 million of oil is extracted and the fixed percentage is 15%, $1.5 million of capitalized costs to extract the natural resource are depleted. After the purchase, we incurred $300,000 in additional costs to explore and develop the site. This entry would be recorded into the natural resources account, Ore Deposits. Like depreciation and amortization, depletion is a non-cash expense that lowers the cost value of an asset incrementally through scheduled charges to income.
Percentage Depletion Method
Estimating the future selling price, appropriate discount rate and future extraction and delivery costs of reserves that are years away from realization can be a formidable task. Those who hold the full-cost concept argue that the cost of drilling a dry hole is a cost needed to find commercially profitable wells. Others believe that companies should capitalize only on the costs of successful projects.
Recording Depletion
The percentage depletion method requires a lot of estimates and is, therefore, not a heavily relied upon or accepted method of depletion. It does seem ironic that Congress directed the FASB to develop one method of accounting for the oil and gas industry, and when the FASB did so, the government chose not to accept it. Subsequently, the SEC attempted to develop a new approach, failed, and then urged the FASB to develop the disclosure requirements in this area. In addition, they argue that an unsuccessful company will end up capitalizing on many costs that will make it, over a short period of time, show no less income than a successful one. Total costs related to the mine before the first ounce of gold is extracted are, therefore, $1,000,000.
Liquidating Dividends
For example, Atlantic Richfield Co., at one time, reported net producing property of $2.6 billion. To illustrate, at year-end, Callahan Mining had a retained earnings balance of $1,650,000, accumulated depletion on mineral properties of $2,100.000, and paid-in capital in excess of par of $5,435,493. The major accounting problem is to distinguish between dividends that are a return of capital and those that are not.
On the balance sheet, we classify natural resources as a separate group among noncurrent assets under headings such as “Timber Stands” and “Oil Reserves”. Accordingly, on the balance sheet, we report natural resources at total cost less accumulated depletion. On the balance sheet, we classify natural resources as a separate group among noncurrent assets under headings such as “Timber stands” the accumulated depletion of a natural resource is reported on the and “Oil reserves”. Typically, we record natural resources at their cost of acquisition plus exploration and development costs; on the balance sheet, we report them at total cost less accumulated depletion. By crediting the Accumulated Depletion account instead of the asset account, we continue to report the original cost of the entire natural resource on the financial statements.
Recall that the accounting profession uses the term depletion to allocate the cost of natural resources. Chevron Corp. (CVX) reported $19.4 billion in DD&A expense in 2018, more or less in line with the $19.3 billion it recorded in the prior year. In its footnotes, the energy giant revealed that the slight DD&A expense increase was due to higher production levels for certain oil and gas producing fields. The Internal Revenue Service (IRS) requires the cost method to be used with timber.
- Tangible equipment costs include all the transportation and other heavy equipment needed to extract the resource and prepare it for the market.
- The percentage depletion method requires a lot of estimates and is, therefore, not a heavily relied upon or accepted method of depletion.
- In other words, it lets firms match expenses to the revenues they helped produce.
- Because companies can move heavy equipment from one extracting site to another, companies do not normally include tangible equipment costs in the depletion base.
This accounting technique is designed to provide a more accurate depiction of the profitability of the business. Depreciation, depletion, and amortization (DD&A) is an accounting technique that enables companies to gradually expense various different resources of economic value over time in order to match costs to revenues. As a substitute, the SEC argued in favor of a yet-to-be-developed method, reserve recognition accounting (RRA), which it believed would provide more useful information. Under RRA, as soon as a company discovers oil, it reports the value of the oil on the balance sheet and in the income statement. MacLeod may also depreciate on a units-of-production basis the tangible equipment used in extracting the gold. This approach is appropriate if it can directly assign the estimated lives of the equipment to one given resource deposit.
However, some tangible assets (e.g., a drilling rig foundation) cannot be moved. Companies depreciate these assets over their useful life or the life of the resource, whichever is shorter. The process of gradually writing off the initial cost of an intangible asset over its useful life. Currently, companies can use either the full-cost approach or the successful-efforts approach.
