Depreciation, Depletion, and Amortization (DD&A)

What Is Depreciation, Depletion, and Amortization (DD&A)?

Depreciation, depletion, and amortization (DD&A) is an accounting technique that enables companies to gradually expense various different resources of economic value over time in order to match costs to revenues.

Depreciation spreads out the cost of a tangible asset over its useful life, depletion allocates the cost of extracting natural resources, such as timber, minerals, and oil from the earth, and amortization is the deduction of intangible assets over a specified time period; typically the life of an asset.

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

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

Accrual accounting permits companies to recognize capital expenses in periods that reflect the use of the related capital asset. In other words, it lets firms match expenses to the revenues they helped produce.

For example, if a large piece of machinery or property requires a large cash outlay, it can be expensed over its usable life, rather than in the individual period during which the cash outlay occurred. This accounting technique is designed to provide a more accurate depiction of the profitability of the business.

DD&A is a common operating expense item for energy companies. Analysts and investors in the energy sector should be aware of this expense and how it relates to cash flow and capital expenditure.

Depreciation

Depreciation applies to expenses incurred for the purchase of assets with useful lives greater than one year. A percentage of the purchase price is deducted over the course of the asset's useful life. 

Depletion

Depletion also lowers the cost value of an asset incrementally through scheduled charges to income. Where it differs is that it refers to the gradual exhaustion of natural resource reserves, as opposed to the wearing out of depreciable assets or the aging life of intangibles.

Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural resource extraction. Enterprises with an economic interest in mineral property or standing timber may recognize depletion expenses against those assets as they are used. Depletion can be calculated on a cost or percentage basis, and businesses generally must use whichever provides the larger deduction for tax purposes.

Amortization

Amortization is very similar to depreciation, in theory, but applies to intangible assets such as patents**,** trademarks**,** and licenses, rather than physical property and equipment. Capital leases are also amortized.

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

If a company uses all three of the above expensing methods, they will be recorded in its financial statement as depreciation, depletion, and amortization (DD&A). A single line providing the dollar amount of charges for the accounting period appears on the income statement.

Explanations may also be supplied in the footnotes, particularly if there is a large swing in the depreciation, depletion, and amortization (DD&A) charge from one period to the next.

An entry is made on the balance sheet, too. The dollar amount represents the cumulative total amount of depreciation, depletion, and amortization (DD&A) from the time the assets were acquired. Assets deteriorate in value over time and this is reflected in the balance sheet. 

Real World Example

Chevron Corp. (CVX) reported $19.4 billion in DD&A expense in 2018, more or less in line with the $19.3 billion it recorded in the prior year. In its footnotes, the energy giant revealed that the slight DD&A expense increase was due to higher production levels for certain oil and gas producing fields.

Source: U.S. Securities and Exchange Commission.