Understanding the accounting concepts “depreciation” and “depletion” can help investors assess a company’s earnings and asset value. In turn, this can help with investment decisions.
Here is all about decoding depreciation and depletion before investing.
In evaluating a company’s financial health, depreciation and depletion can play an important role.
Depreciation impacts a company’s reported asset values and earnings. Depletion helps establish the value of assets on a company’s balance sheet in a certain period. It also helps with the recording of income-statement costs. In investment analysis, such reports can influence investment decisions.
Below is an exploration of depletion vs. depreciation.
Depreciation is used in accounting to spread a physical asset’s cost over its useful life. It represents the extent to which an asset’s value has been exhausted in any given period. During this period, the company can write off the asset’s value. Such assets commonly include equipment, machinery, or plants, which are expensive.
Companies regularly exercise depreciation so that they can shift asset costs from their balance sheets to their income statements. They can use a number of methods, including straight-line and accelerated.
New assets are usually more valuable than older ones. Depreciation evaluates the loss of asset value over time. Such loss can be due to normal wear and tear as well as inflation and new product models.
Writing off just part of the cost annually permits investors to report more net income in the purchase year. Such income exceeds what they would report otherwise.
There are common depreciation rates for various assets. For example, the rate for asset classes plants and machinery ranges from 15% to 45%, depending on the asset type. Such types can include cars, motorcycles, computers, or even books.
Now, what is depletion? Keep reading.
What is depletion? It is an accrual accounting practice used to allocate the expense of extracting natural resources from the earth. Such resources commonly include oil, minerals, and timber.
Depletion is meant to help accurately identify assets’ value on the balance sheet and record expenses in the proper period on the income statement.
Determining which expenses must be spread out for the use of natural resources requires calculation. In turn, that requires consideration of each different production phase. There are primary factors that affect the depletion base, which are the capitalized costs depleted across accounting periods. Those factors include expenses related to acquisition of property rights and exploration, and land development and restoration.
When it comes to depletion vs. depreciation, both are non-cash expenses that reduce an asset’s cost value incrementally. Depletion, though, refers to the exhaustion of natural resources over time. By contrast, depreciation refers to the wearing out of depreciable assets.
At the close of an accounting period, depreciation is booked for all capitalized assets that are not yet wholly depreciated. The accountant enters a debit to depreciation cost, which streams through to the income statement. They also enter a credit to accumulated depreciation, which goes on the balance sheet.
Because it does not represent a cash outflow, depreciation is considered a non-cash charge. While an asset might be paid in full when purchased, the expense is booked in increments. That is because assets benefit the company over a protracted period. However, the depreciation charges still lower a company’s earnings, which helps the company tax-wise.
In depletion, costs linked to natural resource extraction are capitalized. When that occurs, the expenses are allocated systematically based on the resources extracted, across different periods. Until expense recognition occurs, the costs are held on the balance sheet.
When conducting financial analysis, investors can use what these companies report on their financial statements to assess their financial conditions. They can also use a company’s dividend payout ratio to learn how much money it returns to shareholders. That can be found on financial statements as well. Depletion also permits investors to notate a natural resource’s value as it is harvested or extracted.
Depletion vs. depreciation. While the accounting concepts are different, they both can be used in making investment decisions. Understanding the terms can help investors determine companies’ value as well as future earnings prospects. This can help them decide where to invest their capital.
Yieldstreet, the leading alternative investment platform, also removes much of the investment guesswork through its robust screening process.
Investing in “alternatives” to the stock market — asset classes such as art and real estate — is increasingly popular. Investors weary of constant volatility are seeking refuge in the private market which have outperformed stocks in almost every downturn.
But before an opportunity is even posted, it is subject to extensive and rigorous vetting. Factors including appraisals, market trends, and insurance policies are all first considered by Yieldstreet. To date, more than $4 billion has been invested on the platform, which offers the broadest selection available of alternative assets.
Such offerings serve an additional, crucial purpose: diversification. Building a portfolio of varying asset types with different degrees of risk can mitigate overall portfolio risk. It can also guard against economic instability, and potentially improve returns.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.
When looking at depreciation vs. depletion, their differences stand out. However, they are both widely used in financial reporting, and can be used to make more strategic investments. After all, the two concepts are essential in assessing a company’s financial health.
Remember, too, that there is an investment platform that does the vetting for investors.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.