Depletion

What Is Depletion?

Depletion is an accounting method for spreading the cost of a natural resource, such as oil, natural gas, minerals, or timber, over the period in which that resource is extracted and sold. As the resource is removed from the ground or forest, the company records part of its cost as an expense and reduces the book value of the resource on its balance sheet.

Depletion works much like depreciation does for machinery or buildings, and like amortization does for certain intangible assets. The key difference is that depletion is tied to physical output rather than the passage of time. A company that produces more oil in a year records more depletion that year, and less if production slows.

How Depletion Is Calculated

Under the cost method, the company first determines the cost basis of the property, which typically includes the purchase price and certain development costs. It then divides that cost by the estimated total recoverable units, such as barrels or tons, to get a per-unit rate. Multiplying that rate by the units sold during the period gives the depletion expense.

Depletion per unit = Adjusted cost basis ÷ Estimated recoverable units

Period depletion = Depletion per unit × Units sold

Because recoverable units are an estimate, companies revise them as new geological information becomes available, and those revisions change future depletion charges. The estimate often relies on proven reserves reported by the company.

Why It Matters to Investors

Depletion is a non-cash expense. It lowers reported net income without requiring a cash payment in that period, so analysts often compare earnings with cash flow when evaluating resource companies. Changes in reserve estimates can also shift future reported earnings, which is worth checking in a company's financial statement footnotes.

For tax purposes, the United States and some other countries allow a percentage depletion method for certain resources. This method uses a set percentage of gross income from the property rather than cost, and over time it can deduct more than the original investment. Tax rules are complex and change, so the official guidance from the relevant tax authority is the best place to check the details.