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Depreciation, Depletion, and Amortization – Definition
Depreciation, depletion, and amortization (DD&A) refer to an accounting technique that a company uses to match the cast of an asset to the revenue generated by the asset over its economic useful life. When DD&A is used, it allows a company to spread the expenses of acquiring a fixed asset over its useful years.
While depreciation is applicable to tangible assets, otherwise called long-term assets, amortization is applicable to intangible assets. Depletion, on the other hand, is used for natural resources such as oil and gas and other natural extracts, this allows the expenses incurred while exploring and extracting the natural resources to be allocated or spread over the exhaustion or consumption of the natural resource.
A Little More on What is Depreciation, Depletion, and Amortization – DD&A
In a simple language, Depreciation, depletion, and amortization (DD&A) is an accounting method of allocating the expense incurred while purchasing or exploring an asset or natural resource to its actual economic use or useful life. DD&A is often associated with non-cash expenses that can be attributed to assets and natural resources. While companies, whether production and accounting use depreciation and amortization for its assets, depletion is used by energy firms and companies that deal with natural resources. DD&A is a form of accrual accounting that matches capital costs and expenses with the revenue or useful life of an asset. It is an important metric that measures how profitable an asset or natural resource is over a period of time.
Depreciation and Amortization
A company regardless of its size needs a combination of assets and capital for effective operation. There are two types of assets, tangible and intangible assets, otherwise called, long-term assets and current assets. Current assets are assets with useful life of less than a year or one year while assets that have useful lives more than one year are called tangible assets. For assets, whether long-term or current, a percentage of their cost is deducted over their useful lives. While depreciation is used for tangible (long-term) assets, amortization is used for current assets.
Examples of tangible assets are machinery and equipment, business facilities such as warehouses, laboratories, buildings, and other landed properties. (Land is however not a tangible asset). Patents, trademarks, and licenses are examples of intangible assets.
The extraction of natural resources from the earth requires a lot of processes and expenses. For instance, before miners can extract oil and gas from the earth, diverse costs are associated. Depletion, as used in DD&A, is a method applicable for natural resources and extracts, this method helps to match the expense of extracting or mining a natural resource with the revenue generated by the resource through consumption or depletion. Mining industries, oil and gas firms, and other natural-resources companies use depletion which is often calculated on a percentage basis.
Depreciation, Depletion, and Amortization (DD&A) is an accrual accounting method that is used in many companies, especially in the oil and gas sector or by energy companies. This method matches the expenses of acquiring assets or extracting natural resources against their useful life and how much revenue they generate.