Posted by McCool's Tax Service

Depreciation, Depletion, and Amortization (DD&A)

Depreciation, Depletion, and Amortization (DD&A)

Depreciation, depletion, and amortization (DD&A) are accounting techniques that give firms the ability to slowly expense various kinds of resources over time to make cost and revenue match. 

Depreciation is the slow reduction in the actual recorded value of an asset (tangible) throughout its useful life. Depreciation helps spread expense recognition that applies to the fixed asset when a firm expects to have revenue from the asset. While amortization is a similar concept, it applies to the use of an intangible asset for the period of its useful life. 

Amortization is a common term in the oil and gas field that covers the cost of wells, properties, and other equipment, making it part of the overall cost of producing oil and gas. Depreciation and amortization apply majorly to firms in the energy sector.


Explaining what Depreciation, Depletion, and Amortization means (DD&A)

Accrual accounting allows the firm to recognize and note capital expenses through the period that showed how the capital assets were used. This means that they can match expenses to the revenue that came from the production.

For instance, if a property or a large piece of manufacturing equipment needs vast cash, the expense can spread over its useful life and not the single period that the cash outlay happened. With this accounting approach, businesses can accurately express profit in their business. 

These are familiar operating expenses in energy firms. Investors and analysts need to know this expense and its relation to cash flow alongside capital expenditure. 


Depreciation

This refers to all expenses that the company incurs to buy an asset that has a useful life over a year. There is a percentage of the item's purchase price that will be deducted over the period of its useful life. 


Depletion

The idea behind depletion is to bring down the cost value of an asset incrementally using scheduled charges that applies to income. It stands out in that it talks about the slow exhaustion of reserves of natural resources. This is different from the wearing out of depreciable assets. 

Miners, loggers, drillers, and other related companies that extract natural resources, etc., all use depletion expenses. Firms with an economic interest in timber or mineral properties can use depletion expense against their properties and assets as they use them. The calculation of depletion can be via a cost or percentage basis.  Most times, businesses will go with the one that gives them the largest deduction for tax. 


Amortization

Amortization is like depreciation, although it talks more about intangible assets like a trademark, patents, licenses, etc., as opposed to equipment and physical properties. 


Recording Depreciation, Depletion, and Amortization (DD&A)

A company that uses the entire three expensing methods will record it as depreciation, depletion, and amortization on their financial statement. There will be a single line on the income statement, which gives the dollar amount of charges that apply to the accounting period. 

There might also be an explanation in footnotes, especially if the charge on depreciation, depletion, and amortization has a large swing from a particular period to the other.

There will also be an entry on the balance sheet. The dollar amount stands for the total amount of depreciation, depletion, and amortization from the asset acquisition period. Assets lose value with time, which reflects in the company's balance sheet.


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