Natural Resources and Depletion

Natural resources

Resources supplied by nature, such as ore deposits, mineral deposits, oil reserves, gas deposits, and timber stands, are natural resources or wasting assets. Natural resources represent inventories of raw materials that can be consumed (exhausted) through extraction or removal from their natural setting (e.g. removing oil from the ground).

When property is purchased, a journal entry assigns the purchase price to the two assets purchased—the natural resource and the land.  If we purchased an ore mine for $650,000 cash and we determined the land value was $50,000 and the Ore Deposit value was $600,000, the entry would be:

Land 50,000
Ore Deposits 600,000
     Cash 650,000
To record purchase of land and mine.

After the purchase, we incurred $300,000 in additional costs to explore and develop the site.  This entry would be recorded into the natural resources account, Ore Deposits.

Ore Deposits 300,000
     Cash 300,000
To record costs of exploration and development.

On the balance sheet, we classify natural resources as a separate group among noncurrent assets under headings such as “Timber stands” and “Oil reserves”. Typically, we record natural resources at their cost of acquisition plus exploration and development costs; on the balance sheet, we report them at total cost less accumulated depletion. (Accumulated depletion is similar to the accumulated depreciation used for plant assets.) When analyzing the financial condition of companies owning natural resources, exercise caution because the historical costs reported for the natural resources may be only a small fraction of their current value.

Depletion is the exhaustion that results from the physical removal of a part of a natural resource. In each accounting period, the depletion recognized is an estimate of the cost of the natural resource that was removed from its natural setting during the period. To record depletion, debit a Depletion account and credit an Accumulated Depletion account, which is a contra account to the natural resource asset account.

By crediting the Accumulated Depletion account instead of the asset account, we continue to report the original cost of the entire natural resource on the financial statements. Thus, statement users can see the percentage of the resource that has been removed. To determine the total cost of the resource available, we combine this depletion cost with other extraction, mining, or removal costs. We can assign this total cost to either the cost of natural resources sold or the inventory of the natural resource still on hand. Thus, we could expense all, some, or none of the depletion and removal costs recognized in an accounting period, depending on the portion sold. If all of the resource is sold, we expense all of the depletion and removal costs. The cost of any portion not yet sold is part of the cost of inventory.

This video will demonstrate the topic: