Accounting for Natural Resources¶
Accounting for natural resources, such as minerals, oil, and gas, differs from traditional depreciation accounting. The key difference lies in how the cost of the resource is allocated as it is extracted or depleted.
Depletion of Purchased Natural Resources¶
When a company purchases a fully developed natural resource, the cost is allocated based on the quantity extracted. This process is called depletion.
Example:
- Purchase Price of Mine: ₹100 crore
- Estimated Mineral Quantity: 100 lakh tons
- Extraction in Year 1: 10 lakh tons
Depletion in Year 1: (₹100 crore / 100 lakh tons) * 10 lakh tons = ₹10 crore
Exploration and Development of Natural Resources¶
When a company explores and develops a natural resource, the accounting becomes more complex, especially regarding unsuccessful exploration efforts. Two main methods are used:
-
Full Cost Method: All exploration costs, both successful and unsuccessful, are capitalized as part of the cost of the natural resource.
-
Successful Efforts Method: Only the costs of successful exploration efforts are capitalized. Costs related to unsuccessful efforts are expensed immediately.
Example: Oil and Gas Exploration
- Drilling Locations: 10
- Cost per Location: ₹30 crore
- Total Exploration Cost: ₹300 crore
- Successful Locations: 2
- Estimated Oil Quantity in Successful Locations: 10 crore barrels
Full Cost Method:
- Value of Natural Resource: ₹300 crore (All exploration costs)
- Depletion per Barrel: ₹300 crore / 10 crore barrels = ₹30 per barrel
Successful Efforts Method:
- Value of Natural Resource: ₹60 crore (2 successful locations * ₹30 crore/location)
- Depletion per Barrel: ₹60 crore / 10 crore barrels = ₹6 per barrel
- Expense: ₹240 crore (8 unsuccessful locations * ₹30 crore/location) is expensed immediately.
Key Difference: The full cost method capitalizes all exploration costs, while the successful efforts method only capitalizes the costs of successful projects and expenses the rest immediately. This results in significantly different reported earnings, especially in the early stages of exploration.
Depletion vs. Depreciation¶
While the term "depreciation" was used for simplicity in some explanations, the correct term for allocating the cost of natural resources is depletion.
Accounting for Growing Assets¶
Assets like teakwood farms or poultry may appreciate in value due to natural growth or aging. Generally, this increase in value is not recognized in the financial statements until the asset is sold. However, the costs incurred each year to maintain or grow these assets are capitalized.
Example:
A teakwood farm requires annual maintenance costing ₹10 lakhs. This ₹10 lakhs would be added to the asset's cost each year. The increased value of the teakwood due to its growth would not be recognized until the trees are harvested and sold.
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