Journalizing Adjusting Entries for Depletion

When this happens, the company will either have a loss or show a gain depending on the difference between the asset’s sale price and its book value. Depletion is the process of allocating the depletable cost of natural resources to expense as individual units of the resource are extracted.

Journalizing Adjusting Entries for Depletion

The cost to prepare the property for asset extraction, which includes the cost of such items as tunnels and wells. The cost to locate assets that may then be depleted. In most cases, these costs are charged to expense as incurred. Combining the amounts from the operating, investing, and financing activities, the SCF reports an increase in cash of $850. This agrees with the change in the Cash amounts reported on the balance sheets dated December 31, 2020 and June 30, 2021. B. Determine the amount of depletion expense for the current year.

Extracted and sold

Buildings, machinery, furniture, equipment and the like are all reported in a similar fashion. For example, the cost of constructing a retail store includes money spent for materials and labor as well as charges for permits and the fees charged by architects and engineers. These are normal and necessary to get the structure into condition and position to help generate revenues.

  • The depreciation on the furniture should just be for one month.
  • This account is often used when an organization makes a purchase but does not pay cash right away.
  • The units of production method is different from the two above methods in that while those methods are based on time factors, the units of production is based on usage.
  • In this course, we concentrate on financial accounting depreciation principles rather than tax depreciation.
  • Depletion is a process of allocating the cost of natural resource reserves to expense, using units-of-production Depreciation.

In this example, a building was bought for $600,000 and later sold after two years for $290,000. Thus, net income for the entire period of use must be reduced by the $310,000 difference regardless of the approach applied.

Types of Depletion Expense

Each one of these entries adjusts income or expenses to match the current period usage. This concept is based on thetime period principle which states that accounting records and activities can be divided into separate time periods. Accounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level. Sales returns and allowances must be properly tracked by accounting using journal entries. Review the process for recording sales returns and allowances with examples. Prepare the journal entry to record the depletion expense.

  • The company would be able to take an additional $10,000 in depreciation over the extended two-year period, or $5,000 a year, using the straight-line method.
  • A report of an organization’s revenues, expenses, gains, and losses over a specified time period.
  • Using the net sales information from and the gross profits given, it is possible to calculate the cost of goods sold.
  • Other examples include computers, furniture, fixtures, and equipment.
  • If a trade does not have commercial substance, net book value is retained so that no gain is recognized.

Both these methods are utilized for calculating the periodic value of the respective asset/resource. Depending on the firm and its resources or assets underuse, these methods gradually reduce the value of the respective resource or asset.

Prepare the journal entry to record the depletion expense.

An aging of the accounts in the customer ledger indicates estimated doubtful accounts of $450,000. An aging of the accounts in the customer ledger indicates estimated doubtful accounts of $575,000. Paragon Tire Co.’s perpetual inventory records indicate that $2,780,000 of merchandise should be on hand on March 31, 2019. The physical inventory indicates that $2,734,800 of merchandise is actually on hand. Journalize the adjusting entry for the inventory shrinkage for Paragon Tire Co. for the year ended March 31, 2019.

What is depletion basis?

The basis of depletion is the capitalised costs which have been reduced over several accounting periods. Four key factors are influencing the foundation of depletion: *Acquisition: *It refers to the costs connected to the purchase or lease of land ownership rights, which the client claims have natural resources.

The following journal entries reduce the asset’s book value to $324,500 (cost of $600,000 less accumulated depreciation of $275,500). Thus, a gain of $25,500 is recognized ($350,000 less $324,500). Because the straight-line method is applied, depreciation expense is a consistent $114,000 each year. As a result, the net book value reported on the balance sheet drops during the asset’s useful life from $600,000 to $30,000. At the end of the first year, it is $486,000 ($600,000 cost minus accumulated depreciation $114,000). At the end of the second year, net book value has been reduced to $372,000 ($600,000 cost minus accumulated depreciation of $228,000).

Determine the depreciation expense for the final fifteen years of the asset’s life, and create the journal entry for year five. On the income statement, depreciation on the building appears as part of the cost of ore sold and is carried as part of inventory cost for ore not sold during the period. On the balance sheet, accumulated depreciation on the building appears with the related asset account.


Assets are occasionally obtained through exchange. Reported cost is established based on the fair value of the property surrendered because that measures the company’s sacrifice. The asset received is only recorded at its own fair value if the value of the asset given up cannot be determined. When more than one asset is acquired in a transaction, the cost allocation is based on the relative fair values of the items received.

Journalizing Adjusting Entries for Depletion

There were no unpaid dividends at either the beginning or the end of the year. Caldwell Mining Co. acquired mineral rights for $127,500,000. The mineral deposit is estimated at 425,000,000 tons. During the current year, 42,000,000 tons were mined and sold. Glacier Mining Co. acquired mineral rights for $494,000,000. The mineral deposit is estimated at 475,000,000 tons. During the current year, 31,500,000 tons were mined and sold.

How Depletion Works

December’s electric bill is always due in January. Since the expense was incurred in December, it must be recorded in December regardless of whether it was paid or not. In this sense, the expense is accrued or shown as a liability in December until it is paid. Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. Chevron Corp. reported $19.4 billion in DD&A expense in 2018, more or less in line with the $19.3 billion it recorded in the prior year.

  • Calculate the depletion expense for the next five years and create the journal entry for year one.
  • On December 31, 20X4, Fairfield’s auditors raise concerns that the plant’s market value might be below its book value due to the failure of the j phone.
  • A. Sold merchandise on account, $72,500 with terms 2/10, n/30.
  • These are usually paid as cash, but can sometimes take the form of stock.
  • Straight line basis is the simplest method of calculating depreciation and amortization, the process of expensing an asset over a specific period.

It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity. Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life to account for declines in value over time. Depreciation, depletion, and amortization (DD&A) are accounting techniques that enable companies to gradually expense resources of economic value. To show how depletion is calculated, assume that JDD Company pays $18 million for land on which to drill oil. Other capitalized costs relating to exploration and development are $14 million and so the total cost is $32 million.

A university’s fiscal year might begin on July 1 and end on June 30. A retailer may begin their fiscal year on February 1 and end on January 30, after the holiday shopping season is over. Spreading investments among a variety of assets in order to potentially maximize a return and to minimize risk. If one of those investments goes bad, it will have less of an effect on the overall finances of an organization. Like liabilities, debt is money or other financial obligations that an organization owes. Debts almost always refer to financial obligations due to a bank or other lender.

How is depletion per unit calculated?

To calculate the depletion per unit you take the total cost less salvage value and divide it by the total number of estimated units. The expense is calculated by multiplying the depletion per unit by the number of units consumed or sold during the current period.

The cash flow statement for the month of June illustrates why depreciation expense needs to be added back to net income. Good Deal did not spend any cash in June, however, the entry in the Depreciation Expense account resulted in a net loss on the income statement. On the SCF, we convert the bottom line of the income statement for the month of June (a loss of $20) to the net amount of cash provided or used by operating activities, which was $0. This is done with a positive adjustment which adds back the $20 of depreciation expense. Companies depreciate plant assets erected on extractive industry property the same as other depreciable assets. If such assets will be abandoned when the natural resource is exhausted, they depreciate these assets over the shorter of the physical life of the asset or life of the natural resource.

The company will not be able to recover the asset’s book value through these cash flows. As a result, the fair value of the building must be determined to calculate the amount of any loss to be reported. To illustrate, assume a building is purchased by a company on January 1, Year One, for cash Journalizing Adjusting Entries for Depletion of $600,000. Based on experience with similar assets, officials believe that this structure will be worth only $30,000 at the end of an expected five-year life. GAAP does not require any specific computational method for determining the annual allocation of the asset’s cost to expense.

Journalizing Adjusting Entries for Depletion

Plant assets and natural resources are tangible assets used by a company to produce revenues. On the income statement, depreciation expense is recorded for plant assets and depletion expense is recorded for natural resources. On the balance sheet, accumulated depreciation appears with the related plant asset account and accumulated depletion appears with the related natural resource 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.

The annual depreciation is $9,600 ([$58,000 – 10,000] ÷ 5). However, the asset is purchased at the beginning of the fourth month of the fiscal year. The company will own the asset for nine months of the first year. The depreciation expense of the first year is $7,200 ($9,600 × 9/12). Indicates the efficiency by which a company uses its property and equipment to generate sales revenues. If a company has large amounts reported for various fixed assets but fails to create high revenue balances, the ability of management to make good use of those assets has to be questioned. This figure is calculated by taking net sales for a period and dividing it by the average net book value of the company’s property and equipment .

  • They received a good deal because they bought the vehicles together, paying only $75,000 for both.
  • The amount of revenue left after paying all expenses.
  • You are accounting for every transaction—a monetary event—that happens.
  • As of December 31, 2017, $130,000 of accounts receivable remain uncollected.
  • The estimated useful life of the aircraft is 20 years, with an estimated residual value of $5,000,000.
  • Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life to account for declines in value over time.

A report that lists the credit and debit balances of all general ledger accounts. This is an internal document that is usually generated at the end of an accounting period in order to make sure all credits and debits are in balance. Other similar calculations are depreciation, which applies to tangible assets, and amortization, which applies to intangible assets. Applying depreciation also allows an organization to match the cost of an asset to the revenues it helps bring in, fulfilling the matching principle. A reduction in the value of an asset as that asset is used to generate revenue. Assume that 3,000 tons of ore are extracted in Year One and sold in Year Two for $1 million cash.

There are 24,000 shares of common stock held as treasury stock. Journalize the adjusting entry on December 31 for the amortization of the patent rights. Dexter Industries purchased packaging equipment on January 8 for $72,000. The equipment was expected to have a useful life of three years, or 18,000 operating hours, and a residual value of $4,500. The equipment was used for 7,600 hours during Year 1, 6,000 hours in Year 2, and 4,400 hours in Year 3. Determine the expected net realizable value of the accounts receivable as of December 31.