Special Topic – Wasting Assets & Depletion

Definition of Wasting Assets

- Wasting assets are natural resources and other minerals with economic value such as coal, oil,
ore, precious metal such as gold and silver, and precious stones such as diamonds, emeralds, etc.

- By the name itself, to extract the resources or minerals, the assets undergo “wasting” process
which means, the asset is physically consumed and cannot be replaced by hands of men, and if
replaced by way of natural processes.

Accounting Standard for Wasting Assets

- There is no applicable accounting or reporting standard for “wasting asset” alone. However,
for the “exploration and evaluation expenditures” related to the right to evaluate wasting
assets for resources and other minerals are governed by PFRS 6 Exploration for and Evaluation
for Mineral Resources. In fact, “exploration and evaluation expenditures” may qualify as an asset.

- An entity must develop an accounting policy in recognizing “exploration and evaluation

expenditures” as asset. If qualified, such expenditures shall be measured at cost and be classified
as intangible asset.

- Exploration and evaluation assets are also subject to impairment in accordance with PAS 36
Impairment of Assets as provided by PFRS 6 except if the exploration and evaluation asset is part
of cash-generating units or group of cash-generating units on which some provisions of PFRS 8
Operating Segments shall apply in addition.

Accounting for Wasting Assets

Cost of Wasting Assets

PFRS 6 does not address entirely on the cost measurement for wasting assets, but generally, the cost
of wasting assets can be categorized as follows:

 Acquisition cost – the amount paid to obtain the right over the property itself and any residual
value for the asset (such as land value) shall be deducted for purposes of depletion.
Alternatively, the land value may be set up as a separate “land” account and the other cost to
the wasting asset or natural resources or any appropriate account that will fit.

 Exploration cost – the amount incurred BEFORE achieving technical feasibility and
commercial viability for extracting mineral resources can done. It can be accounted for under:

o Successful effort method – exploration costs directly related to “successful”

exploration and discovery of mineral resources are capitalized as part of the asset.
However, for “unsuccessful” exploration and discovery, the cost is expensed
immediately. This is applied method in practice by large and successful wasting
entities.

o Full cost method – exploration costs are capitalized as part of the asset regardless of
whether the exploration and discovery are successful or unsuccessful. The rationale for
this is risk and reward obtained in acquiring the asset. This is the applied method in
practice by small wasting entities.

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  Development cost – the amount incurred to extract the mineral resources, which could be
either tangible or intangible.

o Tangible development cost – refers to the costs incurred for tangible assets such as
transportation equipment, heavy machines, tunnels and bunkers. These are not
capitalized as part of the cost of wasting asset but are set up in separate asset accounts
and depreciated in accordance with applicable depreciation policy.

o Intangible development cost – refers to the costs incurred for intangible assets such
as drilling rights, sinking mine shafts and right to construct wells. These are capitalized
as part of the cost of wasting asset.

 Estimated restoration cost – the amount to be incurred for purposes of restoring the wasting
asset back to original condition and is considered part of the cost of wasting asset only if there
is an obligation incurred and exist upon acquiring the asset. Since such cost will be incurred
totally after the exhaustion of the wasting asset, the same shall be discounted using a
discount rate to arrive its present value for purposes of computing the initial value of the
wasting asset.

Accounting for Depletion

- If depreciation is the systematic allocation for the depreciable amount of property, plant and
equipment, and amortization is the systematic allocation for the amortizable value of intangible
assets, then depletion is the systematic allocation for the depletable amount of the wasting asset.

- Depletion refers to the removal, extraction or exhaustion of the natural resources from the
wasting asset.

- The depletion method application is the output method or unit-of-production method and the
amount of depletion is computed as follows:

 Step 1 – The depletable amount of the asset (initial cost minus residual value) is divided by
the estimated units of mineral or natural resources to be extracted to arrive with the
depletion rate per unit.

 Step 2 – The depletion rate per unit is multiplied with the number of units extracted for the
period to arrive with the amount of depletion for the period.

Illustration: Depletion
Waste Life Company acquired a right to explore and evaluate over a wasting asset on January 1,
2020. The cost to acquire the right amounted to P5,000,000 including residual value of P1,000,000.
The related exploration cost amounted to P3,000,000 and the development cost amounted to
P2,000,000 for 2020.
The company estimated that approximately 2,000,000 unit tons of mineral resources are
extractable from the wasting asset good for 10 years.
After that, the wasting asset will be restored for P1,500,000. The discount rate is at 10% and the
present value factor/multiplier is 0.39.
200,000 unit tons of mineral resources were extracted for 2020.
Requirement:
Prepare the required journal entries for 2020 under the following assumptions:
1. All exploration cost and development cost are capitalized.
2. The company accounts only for “successful” explorations which amounts to P1,500,000 and
P1,000,000 development costs relate to tangible equipment with 8 years useful life.

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Solution:
Requirement 1: All exploration cost and development cost are capitalized.
Acquisition cost of the wasting asset, 2020 P 5,000,000
Add: Exploration costs (all) 3,000,000
Add: Development costs (all) 2,000,000
Add: Restoration cost (P1,500,000 x 0.39) 585,000
Initial cost of the wasting asset, 2020 P10,585,000
Less: Residual value of the wasting asset 1,000,000
Depletable amount, 2020 P 9,585,000
Divided by: Estimated units extractable 2,000,000
Depletion rate per unit, 2020 P 4.7925

Journal entry in 2020:

Wasting asset P10,585,000
Cash P10,585,000
To record the acquisition of right over wasting asset
including exploration and development costs
incurred.
Depletion (200,000 unit tons x P4.7925 per unit) P 958,500
Accumulated depletion P 958,500
To record the depletion for 2020.
The amount of depletion of P958,500 will form part of the cost of production or cost of sales account
in the income statement for 2020.
The accumulated depletion will serve as contra-asset account of the wasting asset as follows:
Wasting asset P10,585,000
Less: Accumulated depletion, 2020 958,500
Carrying value, 2020 P 9,626,500
Requirement 2: The company accounts only for “successful” explorations which amounts to
P1,500,000 and P1,000,000 development costs relate to tangible equipment with 8 years useful life.
Acquisition cost of the wasting asset, 2020 P 5,000,000
Add: Exploration costs (successful) (3M – 1.5M) 1,500,000
Add: Development costs (intangible) (2M – 1M) 1,000,000
Add: Restoration cost (P1,500,000 x 0.39) 585,000
Initial cost of the wasting asset, 2020 P 8,085,000
Less: Residual value of the wasting asset 1,000,000
Depletable amount, 2020 P 7,085,000
Divided by: Estimated units extractable 2,000,000
Depletion rate per unit, 2020 P 3.5425
Journal entries in 2020:
Wasting asset P 8,085,000
Cash P 8,085,000
To record the acquisition of right over wasting asset
including successful exploration and intangible
development costs incurred.
Exploration expense P 1,000,000
Cash P 1,000,000
To record the cost incurred related to unsuccessful
explorations.
Equipment P 1,000,000
Cash P 1,000,000
To record the development cost incurred related to
tangible equipment with useful life of 8 years.

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 Depletion (200,000 unit tons x P3.5425 per unit) P 708,500
Accumulated depletion P 708,500
To record the depletion for 2020.

Depreciation expense (P1,000,000 / 8 years) P 125,000

Accumulated depreciation P 125,000
To record the depreciation for 2020 related to
tangible equipment.

The amount of depletion of P708,500 will form part of the cost of production or cost of sales account
in the income statement for 2020.
The accumulated depletion will serve as contra-asset account of the wasting asset as follows:
Wasting asset P 8,085,000
Less: Accumulated depletion, 2020 708,500
Carrying value, 2020 P 7,376,500

Change in Accounting Estimate for Depletion

- Change in accounting estimate for depletion relates to the change in prospective recognition of
amount of depletion in the succeeding periods and it may affect the depreciation of the tangible
equipment in the succeeding periods.

- Change in accounting estimate for depletion may be due to changes in estimated units of mineral
resource extractable from the wasting asset, which causes the entity to incur additional
development costs and revise the depletion rate per unit of mineral resource.

Illustration: Change in accounting estimate for depletion

Assume in the previous illustration for Waste Life Company information as of December 31, 2020:
Wasting asset P10,585,000
Accumulated depletion, 2020 958,500
Total extractable unit tons of mineral resources 2,000,000 unit tons
Total extracted unit tons in 2020 200,000 unit tons

In 2021, the company were able to obtain new information that the total extractable units of
mineral resources should have been 2,500,000 unit tons in total and that the company needed to
incur additional development cost on drillings and sinking mineshafts for P1,050,000. During the
year, 250,000 unit tons of mineral resources were extracted.
Requirement:
Prepare the required journal entries for 2021 in relation to depletion.

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Solution:

Wasting asset P 10,585,000

Add: Additional development costs, 2021 1,050,000
Adjusted cost of wasting asset P 11,635,000
Less: Accumulated depletion, 2020 958,500
Adjusted carrying value, 2021 P10,676,500
Less: Residual value of the wasting asset 1,000,000
Remaining depletable amount, 2021 P 9,676,500
Divided by: Remaining units extractable (2.5M – 200k) 2,300,000
Revised depletion rate per unit starting 2021 P 4.2072

Journal entry in 2021:

Wasting asset P 1,050,000
Cash P 1,050,000
To record the additional development costs incurred
in 2021.
Depletion (250,000 unit tons x P4.2072 per unit) P 1,051,800
Accumulated depletion P 1,051,800
To record the depletion for 2021.
The amount of depletion of P1,051,800 will form part of the cost of production or cost of sales
account in the income statement for 2021.
The accumulated depletion will serve as contra-asset account of the wasting asset as follows:
Adjusted carrying value, 2021 P10,676,500
Less: Accumulated depletion
(P 958,500 + P1,051,800) 2,010,300
Carrying value, 2021 P 8,666,200

Depreciation of Tangible Equipment (Mining Properties)

- The following rules may be applied in depreciating the tangible equipment or mining properties:

Manner of use Useful life to be used Depreciation method

Straight-line method
(normally used if the useful life
Over the SHORTER of the of the tangible equipment is
Only for specific extractive wasting asset’s useful life or SHORTER)
projects the tangible equipment’s
Output method
useful life
(if the useful life of the wasting
asset is SHORTER)

Can be used for future Over the tangible equipment’s

Straight-line method
extractive projects useful life

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Illustration: Depreciation of tangible equipment
Assuming in the previous illustration, Waste Life Company, instead, incurred P11,500,000
development cost as follows:
Drilling rights and sinking mineshafts P2,500,000
Transportation and other equipment, 9 years useful life 9,000,000
The wasting asset is expected to contain 3,000,000 unit tons of mineral resources and the company
was able to extract 300,000 unit tons for the year 2020.
Requirement:
Prepare the required journal entry to record the depreciation of transportation and other
equipment under the following assumptions:
1. The extraction is good for 300,000 unit tons per year.
2. The extraction is good for 500,000 unit tons per year.
3. The transportation and other equipment can be used for future extractive projects with
useful life of 12 years.

Solution:
Requirement 1:

Estimated unit tons extractable 3,000,000

Divided by: Unit tons extractable per year 300,000
Estimated useful life of wasting asset 10 years
Estimated useful life of tangible equipment 9 years
SHORTER useful life (straight-line method will be used) 9 years
Transportation and other equipment P 9,000,000
Less: Residual value 0
Depreciable amount P 9,000,000
SHORTER useful life 9 years
Annual depreciation P1,000,000
Journal entry in 2020:
Depreciation expense P 1,000,000
Accumulated depreciation P 1,000,000
To record the depreciation of transportation and
other equipment for 2020.
Transportation and other equipment P 9,000,000
Accumulated depreciation, 2020 1,000,000
Carrying amount, 2020 P8,000,000

Requirement 2:

Estimated unit tons extractable 3,000,000

Divided by: Unit tons extractable per year 500,000
Estimated useful life of wasting asset 6 years
Estimated useful life of tangible equipment 9 years
SHORTER useful life (output method will be used) 6 years
Transportation and other equipment, 9 years useful life P 9,000,000
Less: Residual value 0
Depreciable amount P 9,000,000
Divided by: Estimated unit tons extractable 3,000,000
Depreciation rate per unit P3 per unit

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 Journal entry in 2020:
Depreciation expense (300,000 unit tons x P3 per unit) P 900,000
Accumulated depreciation P 900,000
To record the depreciation of transportation and
other equipment for 2020.

Transportation and other equipment P 9,000,000

Accumulated depreciation, 2020 900,000
Carrying amount, 2020 P8,100,000
Requirement 3:
Transportation and other equipment P 9,000,000
Less: Residual value 0
Depreciable amount P 9,000,000
Divided by: Estimated useful life 12 years
Annual depreciation P 750,000
Journal entry in 2020:
Depreciation expense P 750,000
Accumulated depreciation P 750,000
To record the depreciation of transportation and
other equipment for 2020.

Transportation and other equipment P 9,000,000

Accumulated depreciation, 2020 750,000
Carrying amount, 2020 P8,250,000

Question: What if in the middle of the operations a sudden “shutdown” occur, how will the entity
depreciate the tangible equipment assuming output method is used as depreciation method?
Answer: The company will temporarily stop depreciating the tangible equipment using the output
method and continue depreciating it using the straight-line method over its own remaining useful life.
Question: What if a year after or several years after the shutdown the company continue the
extractive operation, how will the entity depreciate the tangible equipment?
Answer: The company will continue depreciating the tangible equipment using the output method.
Additionally, the company will revise its depreciation rate per unit using the carrying amount of the
tangible equipment and remaining extractable units of mineral resource.

Illustration: Shutdown and continue

Assuming in the previous illustration, Waste Life Company’s operation is temporarily in a
shutdown in year 2021 and the following information is available:
Transportation and other equipment P9,000,000
Accumulated depreciation 900,000
Remaining useful life 8 years
The company is using output method since 2020.
However, on 2022 the company resumed the operations and another 300,000 unit tons of mineral
resource were extracted.
Requirement:
Prepare the required journal entry to record the depreciation of transportation and other
equipment for 2021 and 2022.

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Solution:
For 2021:
Transportation and other equipment P 9,000,000
Less: Accumulated depreciation, 2020 900,000
Carrying amount, 2020 P 8,100,000
Less: Residual value 0
Depreciable amount P 8,100,000
Divided by: Remaining useful life 8 years
Depreciation for 2021 P1,012,500

Journal entry in 2021:

Depreciation expense P 1,012,500
Accumulated depreciation P 1,012,500
To record the depreciation of transportation and
other equipment for 2021.

Transportation and other equipment P 9,000,000

Accumulated depreciation, 2021
(P 900,000 + P1,012,500) 1,912,500
Carrying amount, 2021 P7,087,500

For 2022:
Carrying amount, 2021 P 7,087,500
Less: Residual value 0
Depreciable amount P 7,087,500
Divided by: Remaining extractable units
(3,000,000 unit tons – 300,000 unit tons in 2020) 2,700,000
Depreciation rate per unit starting 2022 P 2.625

Depreciation expense (300,000 unit tons x P2.625) P 787,500

Accumulated depreciation P 787,500
To record the depreciation of transportation and
other equipment for 2021.

Transportation and other equipment P 9,000,000

Accumulated depreciation, 2022
(P 900,000 + P1,012,500 + P 787,500) 2,700,000
Carrying amount, 2022 P6,300,000

Trust Fund Doctrine Versus Wasting Asset Doctrine

- Under the trust fund doctrine, a company is not allowed to distribute or liquidate to its
shareholders the balance of legal capital as dividends but only to the extent of unrestricted
retained earnings. However, under wasting asset doctrine, company is allowed to distribute
dividends even beyond the balance of unrestricted retained earnings in the form of maximum
dividends distributable.

- The maximum dividend is the total of unrestricted retained earnings and accumulated depletion
less capital liquidated and unrealized depletion on ending unit inventory.

- The amount of capital liquidated is presented as a deduction from total shareholder’s equity.

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- Computation of maximum dividends is as follows:

Retained earnings, unrestricted XXX

Add: Accumulated depletion, balance XXX
Total XXX
Less: Capital liquidated from prior years (XXX)
Less: Unrealized depletion on ending unit inventory (XXX)
Maximum dividends distributable XXX

Illustration: Maximum dividends

Assume the following information for Waste Life Company as of December 31, 2021:
Wasting asset (at cost) P10,676,500
Accumulated depletion, 2021 2,010,300
Ordinary share capital, P100 par value 6,800,000
Retained earnings, unrestricted, 2021 3,500,000

The company were able to extract 250,000 unit tons of mineral resource for the year at P4.2072
per unit. At the end of 2021, the inventory of remaining units unsold is at 20,000 unit tons.
Requirement:
Prepare the required journal entry to record the declaration of maximum dividends for 2021.
Solution:
For 2021:
Retained earnings, unrestricted, 2021 P 3,500,000
Add: Accumulated depletion, 2021 2,010,300
Total P 5,510,300
Less: Capital liquidated from prior years 0
Less: Unrealized depletion in ending units
(20,000 unit tons x P4.2072) 84,144
Maximum dividends declarable for 2021 P5,426,156

Journal entry in 2021: If all P5,426,156 is declared as dividends.

Retained earnings P 3,500,000
Capital liquidated* 1,926,156
Dividends payable P 5,426,156
To record the declaration of dividends for 2021.

Notes: The balance of capital liquidated account of P1,926,156 will be presented as a deduction
from total shareholder’s equity for 2021.

Continue: Assuming in 2022, the company had the following transactions:

Extracted 250,000 unit tons of mineral resource at P4.2072 P 1,051,800
Sold 230,000 unit tons of mineral resource at P30.00 per unit 6,900,000
Unsold units of 40,000 unit tons (20k + 250k – 230k) 168,288
Earned net income for the year 4,932,344

Requirement :
Prepare the required journal entry to record the declaration of maximum dividends for 2022.

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Solution:
For 2021:
Retained earnings, unrestricted, 2022 P 4,932,344
Add: Accumulated depletion, 2022
(P2,010,300 + P1,051,800) 3,062,100
Total P 7,994,444
Less: Capital liquidated from prior years 1,926,156
Less: Unrealized depletion in ending units
(20,000 unit tons x P4.2072) 168,288
Maximum dividends declarable for 2022 P5,900,000

Journal entry in 2022: If all P5,900,000 is declared as dividends.

Retained earnings P 4,932,344
Capital liquidated 967,656
Dividends payable P 5,900,000
To record the declaration of dividends for 2022.

Notes: The balance of capital liquidated account of P2,893,812 (P1,926,156 + P967,656) will be
presented as a deduction from total shareholder’s equity for 2022.

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