Lecture 12 Depletion

Engineering Economics, Lecture 12, Ejaz Gul, FUIEMS, 2009

Engineering EconomicsEngineering EconomicsEngineering EconomicsEngineering Economics

DepletionDepletionDepletionDepletion


Physical assets lose value with passage of Physical assets lose value with passage of

time, it is said that they depreciate in value. time, it is said that they depreciate in value.

With the possible exception of land, this With the possible exception of land, this

phenomenon is the characteristics of all phenomenon is the characteristics of all

physical assets physical assets

Depreciation is the loss in value of asset over timeDepreciation is the loss in value of asset over time

DepreciationDepreciation


Factors Involved in DepreciationFactors Involved in Depreciation

Asset costAsset cost Service lifeService life Residual value (salvage value)Residual value (salvage value) Method of depreciationMethod of depreciation


Depletion• Accounting concept. Accounting concept.

• The depletion deduction allows for the reduction The depletion deduction allows for the reduction

of a natural asset's valueof a natural asset's value

• Depletion is a cost recovery system for the Depletion is a cost recovery system for the

reduction in the natural asset’s value reduction in the natural asset’s value


Depreciation and DepletionDepreciation and Depletion

• Both depreciation and depletion are methods that are used Both depreciation and depletion are methods that are used

to assess the value of a specific type of asset to the asset's lifeto assess the value of a specific type of asset to the asset's life

• Depreciation, refers to assess a artificial asset’s value over that

asset's life. For example, an office building can be used for a number

of years before it becomes run down and is sold.

• Depletion refers to the allocation of the value of natural resources

over time. For example, an oil well has a finite life before all of the oil

is pumped out. Oil will deplete with time.

http://www.investopedia.com/terms/d/depreciation.asp

http://www.investopedia.com/terms/d/depletion.asp


• DepreciationDepreciation refers to the decline in value refers to the decline in value of tangible plant assets. of tangible plant assets. DepletionDepletion is the is the term used to describe the decline in term used to describe the decline in natural resources such as oil, or coal. natural resources such as oil, or coal.

Cost of natural resources should include acquisition costs, Cost of natural resources should include acquisition costs,

exploration costs, and development costs. exploration costs, and development costs. Tangible assets Tangible assets

used in extracting natural resources are normally set up in a used in extracting natural resources are normally set up in a

separate account and depreciated individually.separate account and depreciated individually.


DepletionDepletion

Unit Depletion Rate =Cost - Residual Value

Units

Coal Company purchases land for $3,000,000 from which it expects to extract 1,000,000 tons of coal, the estimated

residual value is $200,000, and it mines 80,000 tons of coal in the first year. Calculate depletion for the year

Coal Company purchases land for $3,000,000 from which it expects to extract 1,000,000 tons of coal, the estimated

residual value is $200,000, and it mines 80,000 tons of coal in the first year. Calculate depletion for the year

Unit Depletion Rate =$3,000,000 - $200,000

1,000,000 tons


Unit Depletion Rate =Cost - Residual Value

Units

Unit Depletion Rate =$3,000,000 - $200,000

1,000,000 tons

Unit Depletion Rate = $2.80 per tonUnit Depletion Rate = $2.80 per ton

Depletion for Year = $2.80 x 80,000 = $224,000Depletion for Year = $2.80 x 80,000 = $224,000

DepletionDepletion


Modified Accelerated Cost Recovery Modified Accelerated Cost Recovery System (MACRS) System (MACRS)

• The Modified Accelerated Cost Recovery System

(MACRS) is the method of asset depreciation. Under

MACRS, all assets are divided into classes which dictate

the number of years over which an asset's value will be

depreciated.

http://en.wikipedia.org/wiki/Asset

http://en.wikipedia.org/wiki/Depreciation


Classes (USA)• 3-year property - Devices for food and beverage manufacture.

Tools for the manufacture of finished plastic

products, fabricated metal products,

and motor vehicles

• 5-year property - Information Systems; Computers / Peripherals

Petroleum drilling equipment

• 7-year property - Office furniture, fixtures, and equipment

• 10-year property - Assets used Industry

Vessels and water transportation equipment

• 15-year property- Telephone distribution plants

Treatment plants

• 20-year property - Municipal sewers and vehicles


Quiz

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Lecture 12 Depletion