depletion

Imagine you buy a hillside containing an estimated one million tonnes of coal. As you dig out and sell the coal, the hill is literally being used up — every tonne removed is a tonne of your purchased resource gone forever. Charging the whole cost of the hill in year one, or pretending it never gets consumed, would both be wrong. The way accountants spread the cost of a natural resource as it is physically extracted is depletion.

Depletion is the systematic allocation of the cost of a natural resource — a mine, an oil field, a timber tract, a quarry — over the units extracted from it. It is the natural-resource cousin of depreciation and amortization, and it works almost exactly like the units-of-production method. You compute a depletion rate per unit: (cost − salvage value) / total estimated recoverable units. Then each period's depletion is that rate times the units actually extracted. For example, a mine bought for 5,000,000 with no salvage value and 1,000,000 tonnes of estimated reserves has a rate of 5 per tonne; extract 80,000 tonnes this year and depletion is 80,000 × 5 = 400,000.

Depletion matters for extractive industries — mining, oil and gas, forestry — where the resource being consumed is the heart of the business. A subtle but important point: the depletion of extracted units that have not yet been sold is not an expense yet; it sits in inventory and becomes cost of goods sold only when the resource is sold, while depletion tied to already-sold units does become expense. The honest caveat is that estimated reserves are exactly that — estimates — and they can change as surveys improve or prices shift, which then changes the depletion rate going forward.