Depletion (Income Statement)
The Non-Cash Charge for Consumption of Natural Resource Assets
Depletion on the income statement is the systematic allocation of the cost of natural resource assets (such as oil, gas, minerals, timber, or coal reserves) over the periods in which those resources are extracted and sold. It is analogous to depreciation for fixed assets but based on units extracted rather than time. Depletion is a non-cash expense that reduces reported earnings and taxable income in extractive industries, reflecting the gradual exhaustion of finite reserves. This charge is typically included in cost of revenue and is crucial for understanding the true cost of production, asset base sustainability, and cash generation in mining, oil & gas, and forestry companies.
What is Depletion?
Depletion is the accounting method used to allocate the capitalized cost of acquiring and developing natural resource reserves over the volume of resources extracted.
Under US GAAP (ASC 930 for extractive activities) and IFRS (IAS 16/IAS 38 elements), depletion applies to wasting assets where value is realized through extraction rather than ongoing use.
It is a non-cash charge similar to depreciation but calculated based on production activity, making it variable with output levels.
Depletion is material primarily in upstream oil & gas, mining, and timber industries.
How Depletion is Calculated
The most common method is units-of-production:
Key Elements
- Depletable Cost Basis: Acquisition, exploration, development costs (minus salvage/residual value)
- Reserves: Proved (oil/gas) or proven/probable (mining); revised estimates change rate prospectively
- Revisions: Reserve changes adjust future depletion (no retroactive adjustment)
Tip: Successful efforts (oil/gas) vs. full cost accounting affects which costs are depletable.
Examples of Depletion
Example 1: Oil Field
Example 2: Mine with Reserve Revision
Example 3: Timber Tract
Higher production volumes increase depletion expense even if costs are fixed.
Presentation in the Income Statement
Depletion is typically reported as:
Common Locations
- Cost of Revenue (most common in extractive industries)
- Within Depreciation, Amortization & Depletion aggregate
- Separate line in detailed operating expenses
Reduces gross profit and operating income; disclosed in footnotes with reserve estimates and rate.
Importance in Financial Analysis
Depletion is key for: - EBITDA calculation (add back non-cash) - Assessing reserve life and replacement (capex vs. depletion) - Evaluating production efficiency and cost per unit - Understanding cash flow sustainability in resource companies
Reserve revisions can materially swing depletion expense and earnings. Low depletion relative to capex may indicate reserve growth.
Warning: Aggressive reserve estimates lower depletion rate, inflating earnings—scrutinize third-party reserve reports.
Key Takeaways
Depletion allocates cost of natural resources based on units extracted.
Non-cash expense, typically in cost of revenue for extractive industries.
Units-of-production method ties expense to production volume.
Added back for EBITDA; reflects reserve consumption.
Monitor reserve revisions and depletion vs. capex for sustainability.
Depletion (Income Statement)
The Non-Cash Charge for Consumption of Natural Resource Assets
Depletion on the income statement is the systematic allocation of the cost of natural resource assets (such as oil, gas, minerals, timber, or coal reserves) over the periods in which those resources are extracted and sold. It is analogous to depreciation for fixed assets but based on units extracted rather than time. Depletion is a non-cash expense that reduces reported earnings and taxable income in extractive industries, reflecting the gradual exhaustion of finite reserves. This charge is typically included in cost of revenue and is crucial for understanding the true cost of production, asset base sustainability, and cash generation in mining, oil & gas, and forestry companies.
Table of Contents
What is Depletion?
Depletion is the accounting method used to allocate the capitalized cost of acquiring and developing natural resource reserves over the volume of resources extracted.
Under US GAAP (ASC 930 for extractive activities) and IFRS (IAS 16/IAS 38 elements), depletion applies to wasting assets where value is realized through extraction rather than ongoing use.
It is a non-cash charge similar to depreciation but calculated based on production activity, making it variable with output levels.
Depletion is material primarily in upstream oil & gas, mining, and timber industries.
How Depletion is Calculated
The most common method is units-of-production:
Key Elements
- Depletable Cost Basis: Acquisition, exploration, development costs (minus salvage/residual value)
- Reserves: Proved (oil/gas) or proven/probable (mining); revised estimates change rate prospectively
- Revisions: Reserve changes adjust future depletion (no retroactive adjustment)
Tip: Successful efforts (oil/gas) vs. full cost accounting affects which costs are depletable.
Examples of Depletion
Example 1: Oil Field
Example 2: Mine with Reserve Revision
Example 3: Timber Tract
Higher production volumes increase depletion expense even if costs are fixed.
Presentation in the Income Statement
Depletion is typically reported as:
Common Locations
- Cost of Revenue (most common in extractive industries)
- Within Depreciation, Amortization & Depletion aggregate
- Separate line in detailed operating expenses
Reduces gross profit and operating income; disclosed in footnotes with reserve estimates and rate.
Importance in Financial Analysis
Depletion is key for: - EBITDA calculation (add back non-cash) - Assessing reserve life and replacement (capex vs. depletion) - Evaluating production efficiency and cost per unit - Understanding cash flow sustainability in resource companies
Reserve revisions can materially swing depletion expense and earnings. Low depletion relative to capex may indicate reserve growth.
Warning: Aggressive reserve estimates lower depletion rate, inflating earnings—scrutinize third-party reserve reports.
Key Takeaways
Depletion allocates cost of natural resources based on units extracted.
Non-cash expense, typically in cost of revenue for extractive industries.
Units-of-production method ties expense to production volume.
Added back for EBITDA; reflects reserve consumption.
Monitor reserve revisions and depletion vs. capex for sustainability.
Related Terms
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