It's often used to describe:
* The weather: "The desert was as dry as a bone, with not a drop of rain in sight."
* Soil: "The garden soil is as dry as a bone, I need to water it immediately."
* Food: "The bread was so stale it was as dry as a bone."
* Anything lacking moisture: "My throat was as dry as a bone after talking for hours."
The image of a bone, which is naturally dry and brittle, is used to emphasize the extreme lack of moisture in whatever is being described.