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DEPLETION NOTES

Introduction

Depletion is the removal or extraction of wasting assets. There is no IFRS standard that guides the
accounting for depletion. There is only IFRS 6 which guides ‘exploration and evaluation’ costs which are
costs that are included in accounting for depletion. Just like depreciation, depletion is not a matter of
valuation, but is rather a cost accumulation system for wasting assets. It is the depreciation counterpart of
wasting assets, just like how depreciation is to plant, property and equipment.

Due to the absence of an IFRS standard, entities are compelled to produce their own accounting
policy regarding depletion.

IFRS 6 Exploration and Evaluation Costs

Exploration and evaluation costs are costs that form part of computing for an asset’s depletion.
These are costs that are incurred:

a. After acquiring the legal right to explore the land purchased in order to look for producible ‘holes’
or resources.
b. Before technical feasibility and commercial viability are demonstrable because the costs after the
two are demonstrable are called development costs.

Costs that are included in E&E are:

1. Acquisition of right to explore


2. Topographical and/or geographical studies
3. Drilling
4. Trenching
5. Sampling
6. Costs to evaluate the technical feasibility and commercial viability of the property
7. General and administrative costs that are directly attributable to the exploration and evaluation
of land property

Measurement of Depletable Amount

Initially, at cost. After, you can either choose between the cost model or the revaluation model
which in the absence of fair value can be substituted with the depreciated replacement cost (also known as
sound value). Also, when measuring for an asset’s depletion, we use the PRODUCTION or OUTPUT
method since using the straight line basis to account for depletion would be harder since it’s relatively hard
to estimate the useful life of a natural resource.

The costs of depletion can be subdivided into four (4):

a. Acquisition Cost

This is basically the initial cost of the asset. It is the amount paid in order to acquire the
right to use the asset. Also, when there is a land value attached to the property, we deduct
the residual land value, just like how we deduct the residual value from plant, property and
equipment, from the initial cost of the asset to arrive at the depletable amount.

b. Exploration Cost

These are cost incurred to locate producible ‘holes’. These costs are part of the
aforementioned E&E list except for number six (6) since number six (6) relates to the
evaluation of the asset – costs which are not normally capitalized. Disclaimer: Not entirely

Depletion Notes Dominic Santiago Lee, CPA


sure though na hindi capitalized yung evaluation costs but so far sa book, it only capitalizes
exploration costs.

In accounting for exploration costs, there two methods which are often used:

a. Successful Efforts Method


b. Full Cost Method

Successful Efforts Method Full Cost Method


We capitalize only costs attributed to finding Contrary to SEM, FCM capitalizes all costs
producible holes. Costs that are incurred for ‘dry incurred, may it be from producible or dry holes. It
holes’ are expensed outright. This is a method hinges on the principle that finding producible
commonly used by large business entities. holes is a “wild goose chase” due to the
unpredictability of its nature. This method is
commonly used by small entities.
Illustration: Differences between SEM and FCM

c. Development Cost

These are costs incurred after E&E. These are now actually the costs incurred to per se
produce the product. The development cost may either be tangible or intangible.

Tangible Development Costs Intangible Development Costs


NOT CAPITALIZED CAPITALIZED
Treated as a separate asset and is depreciated (on
the basis of useful life) between the lower of the
straight line and the output method. When using
-
the output method, use units. Do not use the
estimated total and divide it by the annual expected
units in order to be translated into number of years.
Illustration: Differences between tangible and intangible DCs

d. Estimated Restoration Cost

The ERC is only capitalized when the entity incurs the obligation to comply with a legal
statute or by contract. This is netted against the residual land value and minimizing it
therefore increasing the costs of depletion.

Shutdown

When an entity experiences a shutdown, the depreciation of the tangible assets, or of plant,
property and equipment related to the property, shall CEASE to be in the output method, if in any case it
is. The entity will switch to a straight line basis until the shutdown ends, to by which the entity can go back
to the output method of depreciating assets. (IMPORTANT! Do not forget this.)

Declaration of Dividends

I. Trust Fund Doctrine

In a corporation, the issuance of dividend is only until the balance of its Retained Earnings account.
Under this doctrine, a corporation cannot return shares to its shareholders during the lifetime of the
corporation as this is seen as a trust fund by the entity. However, in the;

II. Wasting Asset Doctrine

According to the WAD, an extraction entity can legally return capital to shareholders during the
lifetime of the corporation.

Depletion Notes Dominic Santiago Lee, CPA


In the WAD, the declaration of dividends is to the extent of both the Retained Earnings account and
the Accumulated Depletion account. This is viewed by the entity as capital liquidated. In the WAD,
the guiding principle is that due to the nature of the wasting asset being irreplaceable and
consumable at once, it is unfair to the shareholders for the entity to be withholding such an amount
as this, the balance of the Accumulated Depletion, are costs that have already been recovered.
Shareholders are also aware of the decreasing capital requirements of an entity engaged in the
extraction of natural resources.

Depletion Notes Dominic Santiago Lee, CPA

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