Depreciation, Depletion, and Amortization Explained

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

Depreciation, depletion, and amortization (DD&A) is an accounting method that lets companies gradually expense economic resources over time to align costs with 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 deducts the value of an intangible asset over its useful lifespan.

Depreciation and amortization are common to almost every industry, while depletion is usually used only by energy and natural-resource firms. They are important to understanding the financial statements of resource extraction businesses.

How DD&A Affects Financial Reporting

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 portion of the purchase price is deducted over 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.

Miners, loggers, and oil and gas drillers frequently use depletion expense. Companies with interests in mineral property or timber can use depletion expenses as these assets are extracted. Depletion is calculated by cost or percentage, and businesses usually choose the method giving the largest tax deduction.

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 DD&A in Financial Statements

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.

The balance sheet includes an entry showing the total DD&A since the assets were acquired. Assets deteriorate in value over time and this is reflected in the balance sheet. 

DD&A in Practice: Chevron Corp Example

Chevron Corp. (CVX) reported a DD&A expense of $19.4 billion in 2018, similar to the $19.3 billion from the previous 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.

The Bottom Line

Depreciation, depletion, and amortization (DD&A) is an accounting technique that spreads capital expenses over an asset’s useful life, helping companies match costs with revenues. It appears as a significant operating expense on financial statements. Analysts and investors often monitor DD&A charges as they impact cash flow and capital expenditure reporting in industries reliant on capital-intensive resources.