Depletion and Amortisation

Depletion and Amortisation

Depletion and amortisation are two important concepts in the valuation of assets. They are often confused as they both demonstrate how the value of an item can be accounted for over the course of its useful life. While amortisation refers to the reduction in the cost of an intangible asset, depletion refers to the reduction in the value of an asset due to usage or wear and tear or due to the depletion of natural resources such as oil, coal, and other fossil fuels. 

What is Amortisation?

Amortisation is the process of spreading the expense of an intangible asset over the asset’s useful life. It is a representation of the asset’s consumption over the course of its useful life. Because the cost of an intangible asset cannot be attributed in one lump sum, it must be spread out over the asset’s useful life to deduct the expense amounts from income taxes.

Patents, trademarks, copyrights, and franchise agreements are examples of intangible assets for which amortisation can be used because it only works on intangible assets. The process of amortisation transfers this asset from the balance sheet to the income statement, allowing the income statement to accurately reflect the asset’s consumption during its useful life.

How do we Calculate Amortisation?

Amortisation is expensed on a straight-line basis, which indicates that the asset’s value falls by the same amount throughout the course of a particular time, which corresponds to the asset’s useful life.

Example of Amortisation

A particular company owns a license for Rs. 30,000, which will expire in 5 years. In the straight-line method of amortisation, the value of the license will decrease as an asset by (Rs. 30,000/5 = Rs. 6,000). So, its value each year will reduce by Rs. 6,000.

What is Depletion?

On the other hand, depletion is an accrual accounting technique that is used to quantify the cost of taking natural resources from the ground, such as lumber, oils, minerals, and other types of minerals. It is similar to amortisation in that it is a non-cash expense that has the effect of reducing the cost value of an asset. Depletion is distinguished by the fact that it relates to the gradual exhaustion of natural resource stocks.

Example of Depletion

Consider the case of a firm that purchases a coal mine. The coal mine will cost Rs. 10 lakhs to construct. The value of the coal mine will drop as coal is removed from the mine over time. This is an idea that is quite intuitive and obvious.

The decrease in the value of the mine as a result of depletion must be recognised in the accounting records. Because depletion refers to the reduction in the number of natural resources available, it is conceptually comparable to the accounting concept of amortisation. On the other hand, depletion is more closely associated with depreciation than amortisation.

How is Depletion in Accounting calculated?

To calculate depletion, there are two methods. They are:

• Percentage Depletion Method
• Cost Depletion Method

Conclusion

To summarise, amortisation and depletion are two concepts that are extremely comparable when it comes to the accounting of assets. During depletion, the asset’s value decreases when the natural resources linked with it dwindle or are used up by other activities.