Depreciation, Depletion and Amortization – DD&A

Depreciation, depletion and amortization (DD&A) are noncash expenses used in accrual accounting, often associated with the acquisition, exploration and development of new oil and natural gas reserves. Depreciation is a means of allocating the cost of a material asset over its useful life, and depletion is used to allocate the cost of extracting natural resources from the earth and is the actual physical depletion of a resource by a company. Amortization is the deduction of capital expenses over a specified time period, typically the life of an asset.

Depreciation and amortization are common to almost every industry, while depletion is usually used only by energy and natural-resource firms.

Accrual accounting allows companies to recognize capital expenses in periods that reflect the use of the related capital asset. If a large piece of machinery or property requires a large cash outlay, it can be expensed over its usable life rather than in the individual period during which the cash outlay occurred. This provides a more accurate depiction of the profitability of the business, and the discrepancy is reconciled in the cash flow statement.

Depreciation applies to expenses incurred for the purchase of assets with useful lives greater than one year. Depreciation generally causes a reduction on the property, plant and equipment line of a balance sheet, though other capital assets could be affected. A percentage of the purchase price is deducted over the course of the asset's useful life. Amortization is very similar to depreciation in theory, but it applies to intangible assets such as patents, trademarks and licenses rather than physical property and equipment. Capital leases are also amortized.

Depletion expense is commonly used by miners, loggers, oil and gas drillers, and other companies engaged in natural-resource extraction. Enterprises with an economic interest in mineral property or standing timber may recognize depletion expenses against those assets as they are used. Depletion can be calculated on a cost or percentage basis, and businesses generally must use whichever provides the larger deduction for tax purposes.

DD&A is a common operating expense item for energy companies, and it combines all these noncash accrual expenses as a single income statement line item. Analysts and investors in the energy sector should be especially aware of this expense and how it relates to cash flow and capital expenditure. Consider Chevron Corporation's 2015 10-K, in which the company reported $21 billion in DD&A expense, up from $16.8 billion in the prior year. The rise was attributed to greater impairments of oil and gas fields.