Depreciation, Depletion, and Amortization (DD&A)

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What is Depreciation, Depletion and Depreciation (DD&A)?

Depreciation, Depletion and Depreciation (DD&A) is an accounting technique that allows companies to gradually spend different resources of economic value over time in order to match costs to revenues.

Depreciation spreads the cost of a tangible capital asset over its useful life, depletion spreads the cost of extracting natural resources such as wood, minerals and petroleum from the earth, and depreciation is the deduction of capital expenditure over a specified period of time, usually the life of an asset.

Depreciation and amortization are common to almost all industries, while depletion is generally used only by energy and natural resource companies. The use of all three is therefore often associated with the acquisition, exploration and development of new oil and natural gas reserves.

Key points to remember

  • Depreciation, Depletion and Depreciation (DD&A) are accounting techniques that allow companies to gradually spend resources of economic value.
  • The use of the three spending strategies is generally associated with the acquisition, exploration and development of new oil and natural gas reserves.
  • The DD&A charge for the accounting period appears on the income statement.

Understanding Depreciation, Depletion and Depreciation (DD&A)

Accrual accounting allows businesses to record capital expenditures in periods that reflect the use of the related asset. In other words, it allows businesses to match spending to the income they helped generate.

For example, if a large appliance or asset requires significant expenditure, it may be expensed over its useful life, rather than in the individual period in which the expenditure was made. This accounting technique is designed to provide a more accurate representation of the company’s profitability.

Depreciation

Amortization applies to expenses incurred for the purchase of assets whose lifespan is greater than one year. A percentage of the purchase price is deducted over the useful life of the asset.

Amortization

Depreciation is very similar to depreciation in theory, but applies to intangible assets such as patents, marks, and licenses, rather than physical goods and equipment. Capital leases are also amortized.

Exhaustion

Depletion also reduces the cost value of an asset incrementally by charging the scheduled charges to earnings. What differs is that it refers to the gradual depletion of natural resource reserves, as opposed to the depletion of depreciable assets or the aging of the life of intangible assets.

Depletion expenses are commonly used by miners, loggers, oil and gas drillers and other companies engaged in natural resource extraction. Companies with an economic interest in mineral property or stumpage can record depletion expenses on these assets as they are used. Depletion can be calculated on a cost or percentage basis, and businesses should generally use the one that provides the larger deduction for tax purposes.

Depreciation, Depletion and Depreciation (DD&A) Record

If a business uses the three spending methods above, they will be recorded in its financial statements as depreciation, depletion and amortization (DD&A). A single line showing the dollar amount of expenses for the accounting period appears on the income statement.

Explanations can also be provided in the footnotes, particularly if there is a large variation in depreciation, depletion and depreciation (DD&A) expense from period to period.

An entry is also made in the balance sheet. The dollar amount shown here represents the total accumulated amount of Depreciation, Depletion and Depreciation (DD&A) since the time the assets were acquired. The value of assets deteriorates over time and this is reflected in the balance sheet.

Example of Depreciation, Depletion and Depreciation (DD&A)

Chevron Corp. (CLC) reported $ 19.4 billion in DD&A spending in 2020, more or less in line with the $ 19.3 billion recorded the previous year. In its footnotes, the energy giant revealed that the slight increase in DD&A spending was due to higher production levels for some oil and gas producing fields.

Source: United States Securities and Exchange Commission.

Special considerations

DD&A is a common operating expense item for energy companies. Energy analysts and investors should be aware of these expenses and how they relate to cash flow and capital spending.

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