Cost depletion is a type of accounting strategy that seeks to identify the expenses that are associated with extracting natural resources for use in a business operation. The goal of this type of determination is to identify the total amount of the expense and how much, if any, of that expense may be tax deductible. Doing so can aid the business in retaining more of its income rather than paying an unnecessary amount of tax, which in turn means more resources to further develop the company itself.
The process of identifying cost depletion begins by identifying the type of natural resources that are extracted as part of the business operation. For example, the business may focus on mining operations that involve extracting different types of minerals or even oil deposits through the use of drilling and well operations. By defining what operations within the business model may involve extraction of those resources, it is easier to determine the expenses that are associated with those extractions and may be eligible for a tax break of some sort.
After identifying what extracting operations do incur costs, the next phase of determining cost depletion has to do with assessing the exact costs associated with those extraction efforts. The goal here is to identify each type of expense involved and incurred during the tax period. Doing so not only can lead to making it possible to claim legitimate deductions on tax returns, but also provide the company with a more comprehensive perception of what is being spent in order to manage those extractions. This means that along with identifying possible tax deductions, the data collected as part of the cost depletion may also form the basis for refining the operation so those extraction expenses can be reduced over time.
Since cost depletion is also relevant to calculating taxes properly, the final phase of the process will focus on utilizing current tax laws and regulations as the means of deciding which of those expenses can in fact be claimed as deductions. Depending on the nature of those tax laws, all or only a percentage of the extraction costs may be used to secure tax breaks. Since tax regulations can change from one year to the next, taking the time to review all laws relevant to that tax year will go a long way toward making sure the company does claim all allowed tax breaks, retaining those funds for future business activities.