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

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

Let me explain DD&A to you directly: it's an accounting technique that lets companies gradually expense different resources of economic value over time, matching those costs to the revenues they generate.

Depreciation spreads the cost of a tangible asset over its useful life. Depletion allocates the cost of extracting natural resources like timber, minerals, and oil from the earth. Amortization deducts the value of intangible assets over a specified period, usually the asset's life.

You'll see depreciation and amortization in almost every industry, but depletion is mainly for energy and natural-resource firms. When all three are used together, it's often tied to acquiring, exploring, and developing new oil and natural gas reserves.

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

In accrual accounting, companies can recognize capital expenses in periods that reflect the actual use of the related asset. This means you match expenses to the revenues they help produce.

For instance, if you have a large cash outlay for machinery or property, you expense it over its usable life instead of all at once in the period of purchase. This gives a more accurate picture of the business's profitability.

DD&A is a standard operating expense for energy companies. If you're an analyst or investor in that sector, pay attention to how this expense connects to cash flow and capital expenditure.

Depreciation

Depreciation covers expenses for assets with useful lives longer than one year. You deduct a percentage of the purchase price over that life.

Depletion

Depletion reduces an asset's cost value incrementally through charges to income. It differs because it deals with the gradual exhaustion of natural resource reserves, not the wear and tear of depreciable assets or the aging of intangibles.

This expense is common for miners, loggers, oil and gas drillers, and similar companies. If your enterprise has an economic interest in mineral property or timber, you can recognize depletion as those assets are used. Calculate it on a cost or percentage basis, and generally use the method that gives the larger tax deduction.

Amortization

Amortization is theoretically similar to depreciation but applies to intangible assets like patents, trademarks, and licenses, not physical property or equipment. Capital leases also get amortized.

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

When a company uses all three methods, they record them as DD&A in the financial statements. You'll see a single line on the income statement with the dollar amount of charges for the period.

Footnotes might explain details, especially if there's a big change in the DD&A charge from one period to another.

On the balance sheet, there's an entry too. It shows the cumulative total of DD&A from when the assets were acquired. Assets lose value over time, and this is reflected there.

Real World Example

Take Chevron Corp. (CVX) as an example: they reported $19.4 billion in DD&A expense in 2018, which was about the same as the $19.3 billion from the year before. In their footnotes, they noted the slight increase came from higher production in certain oil and gas fields.