Depreciation vs. Depletion: What’s the Difference?

Businesses that own long-term assets must account for how these assets lose value over time. This is a fundamental accounting process required for accurate financial reporting and tax filings. Two methods for this are depreciation and depletion. While both allocate an asset’s cost, they apply to different types of assets and reflect different kinds of value reduction.

Understanding Depreciation

Depreciation is the accounting method used to allocate the cost of a tangible asset over its useful life. It applies to assets that wear out, become technologically outdated, or otherwise lose their value over a period of time. This applies to man-made items a business uses to operate, such as company vehicles, manufacturing machinery, computer equipment, office furniture, and buildings. Land is a notable exception and is not depreciated because it has an indefinite useful life.

To calculate depreciation, three pieces of information are needed: the asset’s initial cost, its estimated salvage value, and its useful life. The initial cost includes the purchase price plus costs like shipping or installation. Salvage value is the estimated residual value of an asset at the end of its useful life, which is the estimated period the asset is expected to be in service.

The most common method for calculating this expense is the straight-line method. The asset’s cost, less its salvage value, is expensed evenly over its useful life. For example, a delivery company purchases a van for $55,000 and expects it to have a useful life of five years and a salvage value of $5,000. The annual depreciation expense is calculated as ($55,000 cost – $5,000 salvage value) / 5 years, which equals $10,000 per year.

While the straight-line method is common for bookkeeping, different rules apply for tax purposes. The primary method for tax depreciation in the United States is the Modified Accelerated Cost Recovery System (MACRS), which allows for larger deductions in the early years of an asset’s life. Businesses may also be eligible for bonus depreciation, allowing a significant upfront deduction. For 2025, the bonus depreciation rate is 40% for qualified assets, though this benefit is scheduled to phase out.

Understanding Depletion

Depletion is an accounting concept used exclusively for allocating the cost of extracting natural resources. Instead of wearing out like a machine, these assets are physically removed and sold, so the method is tied to the physical consumption of these reserves. Examples of assets subject to depletion include crude oil reserves, natural gas deposits, mineral mines, and timber tracts.

The cost depletion method requires the asset’s basis (acquisition, exploration, and development costs), the total estimated recoverable units, and the number of units extracted. The total cost is divided by the estimated recoverable units to determine a depletion rate per unit. For instance, if a mineral deposit costs $2 million and contains 500,000 tons of ore, the rate is $4 per ton. If the company extracts 40,000 tons in a year, the depletion expense is $160,000.

For tax purposes, businesses can choose between cost depletion and percentage depletion, using whichever method results in a larger deduction. Percentage depletion calculates the expense based on a percentage of the property’s gross income. This deduction is limited to 50% of the taxable income from the property, or 100% for oil and gas properties. A unique feature of percentage depletion is that total deductions can exceed the asset’s original cost.

Key Distinctions and Similarities

Despite their differences, the two concepts share a financial purpose. Both are non-cash expenses recorded on the income statement, reducing a company’s reported net income without an actual cash outlay in that period. This process serves the accounting principle of matching by aligning the cost of an asset with the revenues it helps generate. Both depreciation and depletion reduce an asset’s book value on the balance sheet and lower a company’s taxable income.