When Depreciation Does Not Give You a Fit ©2004 Dr. B. C. Paul

Intangible Property  Can’t touch a patent, copyright, trade name, franchise  Musical artists make royalties off of their songs (unless you figure out how to swap them on the internet)  Can be hard to define intangible value (to depreciate have to be able to do it)  If I record “Happy Birthday” putting a value on my copyright might be hard  Farfetched Pharmaceuticals new common cold vaccine may have cost $225,000,000 to discover and prove

Amortization  Intangibles general amortize rather than depreciate  Use a straight-line over the useful life (often an agreement or law specifies a length of time)

The Land and Resources Problem  Land is an investment – not a depreciable asset  What if you are pumping oil or gas, or mining a mineral from the land and using it up  Created a Category Called Depletion

Depletion Methods  Cost Depletion  Define the Cost Basis for acquiring or developing an asset  Finding cost for oil can be very significant – have to drill lot of wells to get a good one  Define the units of resource available  Example – Bushy Boys spends $200,000,000 to find and develop an oil field of 50,000,000 barrels  Cost them $4/barrel to drill and find the oil  For 10 years they pump 5,000,000 barrels of oil  Their cost Depletion deduction is  5,000,000 barrels * $4/barrel = $20,000,000 dollars  Note that Cost Depletion is based on the units of something used up – rather than time

Other Depletion Problems  Natural resources are a basic driver for economy well beyond business that produces them  Businesses may put considerable expense out “on- the-line” looking for things before they find them (thus they may really have more at risk than just the cost basis)  Government created % Depletion  Allow them to take a % of the gross-income generated from sales  Theory – the market will price the at risk exploration costs into the product

Depletion % set on difficulty of finding and risk  Easier stuff  Sand and gravel, clay 5%  Coal 10%  Bigger risk to company  Oil and gas 15% for small producers  Only Cost Depletion for Exxon  More Difficult to find but an economic staple  Gold, Silver, Copper, Iron 15%  Harder with less of a basic market  Lead, Zinc, Nickel, Sulfur, Uranium 22%

How Does it Work  Anna Quarry Makes $3,500,000 dollars on gross sales of stone  % Depletion at 5%  $3,500,000 * 5% = $175,000  Quarry will compare this to cost depletion to decide what to take (they can pick the bigger number)