Cost depletion definition
/What is Cost Depletion?
Cost depletion is a method for allocating the cost of natural resource extraction to the units produced. The concept is used to determine the amount of extraction cost that can be charged to expense. The net effect of this calculation is that your reported pre-tax income will be reduced. There is no cost depletion if no natural resources have been extracted.
How to Calculate Cost Depletion
Cost depletion involves the following steps:
Determine the total investment in the resource (such as buying a coal mine).
Determine the total amount of extractable resource (such as tons of available coal).
Assign costs to each consumed unit of the resource, based on the proportion of the total available amount that has been used.
Example of Cost Depletion
International Exploration Company has invested $500 million in a titanium mine. The total estimated extractable amount of titanium is 400,000 tons of ore. Based on this information, the cost per ton of titanium ore is estimated to be $1,250. In its most recent quarter of operations, International extracts 250 tons of titanium ore. At a cost of $1,250 per ton of ore, International can charge $312,500 of its invested cost to expense in the current reporting period.
The Difference Between Cost Depletion and Percentage Depletion
An alternative to cost depletion is percentage depletion, where a mineral-specific percentage is multiplied by the gross income generated by a property during the tax year. There are restrictions on the use of this method. For example, cost depletion must be used for standing timber.
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The Difference Between Cost Depletion and Depreciation
Cost depletion is similar to depreciation, where the cost of a tangible asset is ratably charged to expense over a period of time. There are two key differences between cost depletion and depreciation, which are:
Cost depletion can only be used for natural resources, whereas depreciation can be used for all tangible assets
Cost depletion varies based on usage levels, while depreciation is a fixed periodic charge