 Hello, and welcome to this session in which we will discuss depletion expense. What is the big idea for depletion expense? Simply put, depletion expense is allocating the cost of natural resources to expense. This sounds like depreciation because depreciation basically the same concept. You allocate the cost of property, plant, and equipment to an expense. In this concept, you will see it later. You're going to allocate the cost later on to the intangible asset. We're going to look at some intangible asset to an expense. Now, when you allocate the cost of natural resources, we call this process depletion. This is what we're going to be learning about today. When you allocate the property, plant, and equipment, we call the process depreciation expense. When we're going to learn about intangibles, we call the process amortization. There are basically three things about the same concept, allocating the cost of an asset to an expense account. And this is what happened to all assets. Eventually, they get expensed. We use them up. So natural resources are also called wasting asset. What are the natural resources? Think about timber, iron, oil, petroleum product, gold, silver, minerals. What are the characteristics of natural resources? How do you know you are dealing with a natural resource? What's going to happen is this. You are going to remove the asset from the land. You're going to consume it somehow. And the only way for this asset to replenish itself is by nature. So the nature, or if you want to say the act of God, whatever you believe in, replenish the asset. So the most difficult thing in computing the depreciation expense is finding the depletion base. So the depletion base is the key to solving the depletion expense problems. Because really, depletion, the actual computation is easy. What's going to be difficult is figuring out what's included in the depletion base. And the depletion base, to kind of make it easier for you, very similar to the depreciation base. How much are you going to depreciate? Well, for the property, plant, and equipment, we took the cost minus accumulated depreciation. For depletion, usually we use four factors in determining what goes into the depletion base. Acquisition cost, exploration cost, development cost, and restoration cost. Now this topic is covered in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course or your accounting course. I'm a useful addition. I'm going to supplement. I'm going to help you understand the material better. By doing so, you can do better on your exam. You can do better on your course. Your risk is one month of subscription. Your potential gain is improving your knowledge, improving your grades. And by doing so, passing the CPA exam, don't shortchange yourself. And if not for anything, take a look at my website to find out how well or not well your university did a wing on the CPA exam. This is a list of all the accounting courses that I cover, including advanced accounting, taxation, governmental, as well as other courses where I provide lectures, multiple choice practice, so on and so forth. My CPA supplemental courses are aligned with your Becker, Roger, Wiley, and Glyme. So it's very easy to go back and forth between your CPA review course and my material. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter, and Reddit. If you know anything about my teaching style, every time I have a list of items, guess what, I'm gonna go over each item separately. Starting with acquisition costs, what's the acquisition cost? Well, let's assume you want to extract oil. Well, you have to buy the land or lease the land or pay royalty. The price that you pay is the acquisition cost. It's either leasing, buying the land, paying for the right to search. Those are called acquisition costs. Or sometimes what you do is you pay royalty for an existing wealth. So you just kind of rent it. At this point, wherever you pay, you're gonna create an account called underdeveloped property because the property has not been developed into anything. If your exploration was successful, you're gonna turn this cost into a natural resource. If it's not successful, what you do is you write it off as an expense. For our purposes, we're gonna assume you purchase for a million dollar, a piece of land or you lease it, but your cost is a million dollar. And we're gonna assume your exploration was successful. Therefore, we're gonna turn this one million dollar. We're gonna add to the depletion base. Now, what's gonna happen? You're gonna have additional costs. Now you just, now you have the right to explore that land. Now you're gonna start to explore the land for your natural resource. You're gonna spend some money to find the resources. See if it's there or not. Sometimes you don't know. You buy it, you're taking a chance. If the amount is material, if that exploration cost is material, usually you will capitalize it in the depletion base. But here, there's like basically two, not two school of thought, two viewpoints and they're both accepted by GAP because especially with the oil industry, the government is very heavily involved and there's a lot of politics back and forth. Usually large companies, they expense those costs. Smaller companies, they capitalize them. Da, are we surprised or what? Well, smaller companies, they don't want them to have the income statement because they cannot afford if the search is failed. But large companies, they don't care. They can afford to expense those exploration costs. So the point is exploration costs could be expensed, could be capitalized, depending on the industry. Development costs, now you're starting to develop, you're starting to, you found the resource. Now you're gonna start to put the foundation, bring those heavy equipment to look for the oil. We have two types of development costs. We have tangible equipment costs because you need those equipment to find the oil, to find the resource and we're gonna have intangible development costs. Under tangible equipment costs, we're gonna broke it down into two type of tangible equipment costs. Intangible means what? Tangible means you can see it, you can touch it. That's what tangible is, tangible asset. So under tangible asset, we're gonna differentiate between mobile asset and usually there is no such term as mobile. I use the term mobile to, you know, the removable and immobile asset, immobile asset where you cannot move, move, move to another site. So mobile assets like transportation vehicles, you bring big truck or billdozers to extract, to start your foundation, you can use those trucks and vehicles at some other asset, like transportation and heavy equipment needed to extract the resource. Those you don't capitalize in the depletion base. Why? Because they're accounted for separately. Those are separate assets. Immobile assets, like if you dig a rigged foundation here for this oil, guess what's gonna happen? You're gonna depreciate this separately over its useful life or the life of the resource, whichever the shorter of the two, because you wanna take, they wanna allow you to take more depreciation. However, intangible development cost, like a drilling cost for tunnels and shaft, this is part of the depletion base. So remember, we paid a million dollar for the acquisition cost and now we're gonna assume we spent 300,000 in intangible development cost. The other assets, they're accounted for separately. Now you're gonna have what's called the fourth one is the restoration cost. What is the restoration cost? Basically restore the property to its previous state, natural state. Now I noticed I showed you a forest here. So you're gonna remove that rig and plant the forest. That's not really true, but the point is trying to exaggerate here to make the point. So restoration cost is technically part of the depletion base. And think about it. Your restoration cost is a future cost. You don't know how much it's gonna cost you. So you do, you're gonna estimate the fair value of your obligation. And what's gonna happen, we will have something called asset retirement obligation. We'll learn about this later on. And we will be using the present value of the obligation as today's obligation. And let's assume for the sake of our illustration, you have a $200,000 restoration cost. So simply put acquisition is a million, intangible development cost 300, and restoration cost 200. Those are all goes under the depletion base. And we're gonna assume the depletion base is 1.5 million. We're also going to assume you are gonna be able to extract 150 barrels of oil from this land, from this project. Now we could compute what's called the depletion rate. We'll take the depletion base, which is 1.5 million, divided by how many units you are going to extract. And that's gonna give us the depletion rate per barrel. So every time we extract the barrel, we can deplete $10. And let's assume for year one, to keep going with the example, we extracted 20,000 barrels. Now we're ready to make the journal entry. What we can do is we can debit, depletion expense or inventory for 200,000. Now there's a difference between depletion expense and inventory. And the reason is simple, certain natural resources like oil, when you extract them, there's a readily fair market value for them. So the point I'm trying to make here is, natural resources, they kind of have a specialized accounting, which is we really don't go into, but if you work in this industry, you have to know how it works. The point is, let's assume it's inventory. Let's assume you debited inventory. Well, if you debited inventory and there is a readily available fair market value, then this inventory will be sold and it'll be turned into cost of goods sold, basically into an expense. Or sometime what the company do, as soon as they extract it, they expense it. Why? Because there is a readily available market or what you're doing is the matching. This is the debit. So be careful in your textbook. Each textbook will treat it differently. Just be careful what your textbook, for example, one textbook tell you to use a certain way. Be careful what they ask you and follow what they're asking you. The credit, either you can credit accumulated depletion, like accumulated depreciation, or you can credit the natural resource itself. Again, you have both of these options. Just know what your textbook wants you to do. And this is basically a general idea about what you need to know as an intermediate accounting student or someone preparing for the CPA exam. Now what I suggest you do is to go to my website, farhatlectures.com and work additional multiple choice problem, view additional lectures about this topic. At the end of this recording, I'm gonna remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. Don't shortchange yourself. Give me a try. If you see my resources are helping you, you keep it. If not, you cancel. That's your loss, one month of subscription. Your potential gain is doing better in your classes. It's not really in expense. You're investing in yourself. Don't shortchange yourself. Throw everything at your accounting career. It's worth it at the end. Throw everything at your CPA exam. It will pay dividend for you in the future. Good luck and of course, stay safe.