When this happens, the company will either have a loss or show a gain depending on the difference between the asset’s sale price and its book value. You will learn the journal entries for a variety of situations, including a gain on the sale of an asset, a loss on the sale of an asset, how to realize loss, and what to do when a fire or flood that destroys an asset. This is more informative than reporting only the net amount of $15,000 (which would likely be the case if the contra asset account Accumulated Depreciation was not used). Although it is reported on the balance sheet under the asset section, accumulated depreciation reduces the total value of assets recognized on the financial statement since assets are natural debit accounts. Each year the contra asset account referred to as accumulated depreciation increases by $10,000.
Accumulated amortization and accumulated depletion work in the same way as accumulated depreciation; they are all contra-asset accounts. For tangible assets such as property or plant and equipment, it is referred to as depreciation. If a company uses all three of the above expensing methods, they will be recorded in its financial statement as depreciation, depletion, and amortization (DD&A). A single line providing the dollar amount of charges for the accounting period appears on the income statement. There are balance sheet and income statement entries that must be recorded when getting rid of equipment by scrapping it or selling it. It also discusses intangible assets, how to record them, and how to account for their diminishing value.
For example, a company buys a company vehicle and plans on driving the vehicle 80,000 miles. Since the asset has a useful life of 5 years, the sum of year digits is 15 (5+4+3+2+1). Under the sum-of-the-years digits method, a company strives to record more depreciation earlier in the life of an asset and less in the later years.
- Depletion.Depletion is the method of adjusting the worth of a natural useful resource asset in order that it accounts for the removal of the natural assets in the course of the asset’s life.
- In many cases, firms compute periodic depreciation charges using the units-of-production method.
- Those accounting methods include the straight-line method, the declining balance method, the double-declining balance method, the units of production method, or the sum-of-the-years method.
- Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
- Fixed assets are capitalized in the books of accounts as their benefits are expected to accrue beyond a single accounting period.
To calculate accumulated depletion, you need to determine the depletion rate per unit of the resource and multiply it by the number of units extracted during a specific accounting period. Depletion also lowers the cost value of an asset incrementally through scheduled charges to income. Where it differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or the aging life of intangibles.
Accumulated depreciation has a natural credit balance (as opposed to assets that have a natural debit balance). However, accumulated depreciation is reported within the asset section of a balance sheet. Depreciation is the periodic allocation of the cost of a tangible fixed asset over its useful life.
For example, imagine Company ABC buys a company vehicle for $10,000 with no salvage value at the end of its life. This article looks at meaning of and differences between two of these terms – depreciation and depletion. Analysts and investors in the energy sector should be aware of this expense and how it relates to cash flow and capital expenditure. The previous video gave us a demonstration of the accounting process for depletion but we will review it here. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
Double-Declining Balance Method
This is done by adding up the digits of the useful years and then depreciating based on that number of years. Depletion thus occurs due to the exhaustion of supply of the specific natural resource. https://personal-accounting.org/ For example, Company A buys a company vehicle in Year 1 with a five-year useful life. Regardless of the month, the company will recognize six months’ worth of depreciation in Year 1.
How Depletion Works
A commonly practiced strategy for depreciating an asset is to recognize a half year of depreciation in the year an asset is acquired and a half year of depreciation in the last year of an asset’s useful life. This strategy is employed to fairly allocate depreciation expense and accumulated depreciation in years when an asset may only be used for part of a year. Under the double-declining balance (also called accelerated depreciation), a company calculates what its depreciation would be under the straight-line method. Then, the company doubles the depreciation rate, keeps this rate the same across all years the asset is depreciated and continues to accumulate depreciation until the salvage value is reached. The percentage can simply be calculated as twice of 100% divided by the number of years of useful life.
For example, let’s say an asset has been used for 5 years and has an accumulated depreciation of $100,000 in total. Like depreciation and amortization, depletion is a non-cash expense that lowers the cost value of an asset incrementally through scheduled charges to income. Where depletion differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or aging life of intangibles. The accounting entry for depletion is similar to that of depreciation, with a charge to profit and loss account and accumulation in accumulated depletion account.
If there is an obligation to restore the land to a usable condition, the firm adds these estimated restoration costs to the costs to develop the site. Depletion is an accrual accounting technique used to allocate the cost of extracting natural resources such as timber, minerals, and oil from the earth. In some instances, companies buy only the right to extract the natural resource from someone else’s land.
Every tangible fixed asset has a specific useful life over which its related benefits accrue. For example, a plant manufacturing paper may be expected to have a useful life of 25 years. Thus, in accordance with the ‘matching’ principle of accounts, the cost of the asset the accumulated depletion account is ought to be allocated over its useful life. This periodic charge is calculated and charged as an expense to the profit and loss account each year as ‘depreciation’. Accumulated depreciation is recorded as a contra asset via the credit portion of a journal entry.
Fixed assets are capitalized in the books of accounts as their benefits are expected to accrue beyond a single accounting period. The matching principle of accounts requires that expenses should be recorded in the books in the same period in which their related revenues are recognized. Accordingly, certain proportion of the costs of the fixed assets are required to be expensed out in each accounting period. This can be done through a number of methods like depreciation, depletion or amortization depending on the nature of the fixed asset.