What Are Methods of Depleting or Amortizing?

by Will Gish

Methods of calculating amortization and depletion help businesses understand how much an asset costs as it depreciates. Depleting assets and amortizing assets both lose value over time and eventually expire. However, these terms refer to different types of assets. Two primary methods of depleting a resource and amortizing a resource exist, both intrinsically related to the passage of time.

Depletion and Amortization

Depletion occurs when a business depletes, or completely uses up, a finite resource such as gas, oil, trees or iron. Depleting methods include deforestation, oil drilling, gas wells and the use of natural iron reserves in processes such as steel smelting. Amortization occurs when a business losses rights on intangible assets, such as copyrights, trade marks, patents and goodwill. Amortizing occurs over time, as intangible assets lose economic value or expire.

Method of Calculating Depletion

Units-of-production is the primary method of calculating depletion. As per units-of-production depletion calculations, per unit depletion rate equals the cost of the natural resources, divided by the estimated recoverable units. For instance, assume a company depletes by cutting down trees. That company pays $5 million for a stand of trees capable of producing 10 million cords of wood. The depletion rate equals 50 cents per cord, which means the company loses 50 cents per cord. Assuming the company removes 1 million cords in one year, the total cost for depleting in that year equals $500,000, or $.50 x 1 million. The company can include this as a loss on tax documents.

Method of Calculating Amortization

Straight line as the primary method of calculating amortization. Per this method, amortization expense equals cost, divided by amortization periods. Amortization periods, measured in years, constitutes the shortest of an intangible asset's economic life, legal life or 40 years. For instance, assume a company spends a total of $250,000 on attorney's fees and other associated costs in obtaining a patent. This patent legally lasts for 20 years, but the company expects an economic life of 15 years, and thus uses this as the amortization period. After 15 years, the patent amortizes, meaning it no longer proves any economic value whatsoever. Thus the amortization expense equals $16,666.67, which is $250,000/15.

Depreciation

The terms amortization and depletion often appear alongside depreciation. In many instances, amortization and depletion constitute notions subjugated to the general heading of deprecation and barely merit mention. The 2009 edition of CCH Tax Law Editors' "US Master Tax Guide," for instance, dedicates 86 pages to depreciation, two pages to amortization and five pages to depletion. Depreciation constitute the loss of value over time on all tangible assets other than those qualifying under depletion. This includes buildings, vehicles, manufacturing equipment, furniture, technological equipment, furniture and nearly anything else of value. Congress maintains strict rules regarding legal accounting methods for deducting depreciation from taxes.

About the Author

Will Gish slipped into itinerancy and writing in 2005. His work can be found on various websites. He is the primary entertainment writer for "College Gentleman" magazine and contributes content to various other music and film websites. Gish has a Bachelor of Arts in art history from University of Massachusetts, Amherst.

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