The cost of any production asset that has a declining value over time is recognized on a company profit and loss by depreciation, which defines the rate by which an asset can be expensed. If a company buys a delivery truck they can recognize about 20% of the cost per year. If the truck cost $75000 they can reduce their taxable income by 15k per year. In this way the company recognizes the cost of the asset over its useful life, matching expenses of the asset more closely to the revenue it generates. The other option would be to deduct the entire cost of the truck in the year it was purchased. This gives the company to large of a deduction and rewards companies for overspending on new assets.

Oil wells are similar in that a large purchase price is paid which then supports production and revenue over a period of years. As oil is removed from the well, the value of the well is reduced. Like depreciation on other assets, the depletion allowance allows the enterprise to recognize the cost of the reserve over the productive life of the field.

The code of any production asset that has a declining value over time is recognized on a company profit and loss by depreciation, which defines the rate by which an asset can be expensed. If a company buys a delivery truck they can recognize about 20% of the cost per year. If the truck cost $75000 they can reduce their taxable income by 15k per year. In this way the company recognizes the cost of the asset one it’s useful life, matching expenses of the asset more closely to the revenue it generates. The other option would be to deduct the entire cost of the truck in the year it was purchased. This gives the company to large of a deduction.

Oil wells are similar in that a large purchase price is paid which then supports production and revenue over a period of years. Depreciation allows the enterprise to recognize the cost of the reserve over the productive life of the field.