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

Intangible PropertyIntangible Property

Can’t touch a patent, copyright, trade name, Can’t touch a patent, copyright, trade name, franchisefranchise Musical artists make royalties off of their songs Musical artists make royalties off of their songs

(unless you figure out how to swap them on the (unless you figure out how to swap them on the internet)internet)

Can be hard to define intangible value (to Can be hard to define intangible value (to depreciate have to be able to do it)depreciate have to be able to do it) If I record “Happy Birthday” putting a value on my If I record “Happy Birthday” putting a value on my

copyright might be hardcopyright might be hard Farfetched Pharmaceuticals new common cold Farfetched Pharmaceuticals new common cold

vaccine may have cost $225,000,000 to discover vaccine may have cost $225,000,000 to discover and proveand prove

AmortizationAmortization

Intangibles general amortize rather than Intangibles general amortize rather than depreciatedepreciate

Use a straight-line over the useful life Use a straight-line over the useful life (often an agreement or law specifies a (often an agreement or law specifies a length of time)length of time)

The Land and Resources The Land and Resources ProblemProblem

Land is an investment – not a Land is an investment – not a depreciable assetdepreciable asset

What if you are pumping oil or gas, or What if you are pumping oil or gas, or mining a mineral from the land and using mining a mineral from the land and using it upit up

Created a Category Called DepletionCreated a Category Called Depletion

Depletion MethodsDepletion Methods

Cost DepletionCost Depletion Define the Cost Basis for acquiring or developing an assetDefine the Cost Basis for acquiring or developing an asset

Finding cost for oil can be very significant – have to drill lot of Finding cost for oil can be very significant – have to drill lot of wells to get a good onewells to get a good one

Define the units of resource availableDefine the units of resource available Example – Bushy Boys spends $200,000,000 to find Example – Bushy Boys spends $200,000,000 to find

and develop an oil field of 50,000,000 barrelsand develop an oil field of 50,000,000 barrels Cost them $4/barrel to drill and find the oilCost them $4/barrel to drill and find the oil For 10 years they pump 5,000,000 barrels of oilFor 10 years they pump 5,000,000 barrels of oil Their cost Depletion deduction isTheir cost Depletion deduction is

5,000,000 barrels * $4/barrel = $20,000,000 dollars5,000,000 barrels * $4/barrel = $20,000,000 dollars Note that Cost Depletion is based on the units of something Note that Cost Depletion is based on the units of something

used up – rather than timeused up – rather than time

Other Depletion ProblemsOther Depletion Problems

Natural resources are a basic driver for Natural resources are a basic driver for economy well beyond business that produces economy well beyond business that produces themthem Businesses may put considerable expense out “on-Businesses may put considerable expense out “on-

the-line” looking for things before they find them the-line” looking for things before they find them (thus they may really have more at risk than just the (thus they may really have more at risk than just the cost basis)cost basis)

Government created % DepletionGovernment created % Depletion Allow them to take a % of the gross-income Allow them to take a % of the gross-income

generated from salesgenerated from sales Theory – the market will price the at risk exploration costs Theory – the market will price the at risk exploration costs

into the productinto the product

Depletion % set on difficulty Depletion % set on difficulty of finding and riskof finding and risk

Easier stuffEasier stuff Sand and gravel, clay 5%Sand and gravel, clay 5% Coal 10%Coal 10%

Bigger risk to companyBigger risk to company Oil and gas 15% for small producersOil and gas 15% for small producers Only Cost Depletion for ExxonOnly Cost Depletion for Exxon

More Difficult to find but an economic stapleMore Difficult to find but an economic staple Gold, Silver, Copper, Iron 15%Gold, Silver, Copper, Iron 15%

Harder with less of a basic marketHarder with less of a basic market Lead, Zinc, Nickel, Sulfur, Uranium 22%Lead, Zinc, Nickel, Sulfur, Uranium 22%

How Does it WorkHow Does it Work

Anna Quarry Makes $3,500,000 dollars Anna Quarry Makes $3,500,000 dollars on gross sales of stoneon gross sales of stone % Depletion at 5%% Depletion at 5% $3,500,000 * 5% = $175,000$3,500,000 * 5% = $175,000 Quarry will compare this to cost depletion to Quarry will compare this to cost depletion to

decide what to take (they can pick the bigger decide what to take (they can pick the bigger number)number)