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Unit - Production - Depreciation - Method 2

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55 views3 pages

Unit - Production - Depreciation - Method 2

Uploaded by

Muhammad Siddique
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Unit Production Depreciation Method:

Detailed Explanation with Examples


Introduction
The Unit Production Depreciation method, also known as the Units of Production method, is
a technique for calculating depreciation based on the actual usage or output of an asset
rather than the passage of time. This method is particularly useful for assets where the wear
and tear, or reduction in value, correlates more closely to the amount of activity the asset
experiences rather than the duration over which it is held.

For instance, manufacturing machinery, vehicles, or equipment used for producing goods
are prime candidates for the Unit Production Depreciation method, since the value
decreases proportionally to their usage. This method is widely used when the productivity
or efficiency of the asset is directly related to its physical usage.

Formula for Unit Production Depreciation


The Unit Production Depreciation formula calculates depreciation based on the total
estimated production or usage of the asset. The formula is as follows:

Depreciation Expense = ((Cost of Asset - Salvage Value) / Total


Estimated Production or Usage) × Units Produced in the Period

Where:

 • Cost of Asset: The initial purchase cost of the asset.


 • Salvage Value: The estimated residual value of the asset at the end of its useful life.
 • Total Estimated Production or Usage: The total number of units (e.g., machine hours,
miles driven, or products produced) that the asset is expected to generate over its useful
life.
 • Units Produced in the Period: The actual number of units produced (or used) during
the accounting period.

Steps for Calculation


1. Determine the depreciable cost by subtracting the salvage value from the purchase cost:
Depreciable Cost = Cost of Asset - Salvage Value.

2. Calculate the depreciation per unit by dividing the depreciable cost by the total estimated
production or usage:
Depreciation per Unit = Depreciable Cost / Total Estimated Production or Usage.
3. Determine the depreciation expense for the period by multiplying the depreciation per
unit by the actual units produced or used during the period:
Depreciation Expense for Period = Depreciation per Unit × Units Produced in Period.

Example 1
A company buys a machine for $100,000 with a salvage value of $10,000 at the end of its
useful life. The machine is expected to produce 50,000 units over its lifetime. During the
first year, the machine produces 8,000 units.

Step 1: Depreciable Cost = 100,000 - 10,000 = 90,000


Step 2: Depreciation per Unit = 90,000 / 50,000 = 1.8 per unit
Step 3: Depreciation Expense for First Year = 1.8 × 8,000 = 14,400

Thus, the depreciation expense for the first year is $14,400.

Example 2
A manufacturing firm buys a vehicle for transporting goods for $60,000, with an expected
salvage value of $5,000. The vehicle is expected to run for 150,000 miles during its useful
life. In the first year, it is driven 20,000 miles.

Step 1: Depreciable Cost = 60,000 - 5,000 = 55,000


Step 2: Depreciation per Mile = 55,000 / 150,000 = 0.3667 per mile
Step 3: Depreciation Expense for First Year = 0.3667 × 20,000 = 7,334

Thus, the depreciation expense for the vehicle in the first year is $7,334.

Benefits and Drawbacks

Benefits
• Reflects Actual Usage: The unit production method provides a more accurate
representation of how much value an asset loses based on how much it is used, which
makes it more suitable for assets that degrade based on usage rather than time.

• Fair Value Allocation: This method prevents over-depreciation or under-depreciation,


ensuring that each period gets an appropriate share of the asset's depreciation expense
based on actual productivity.

Drawbacks
• Complex Record Keeping: It requires detailed and accurate tracking of asset usage, which
can be complex for some businesses.

• Inapplicable to Non-Usage Assets: The method is not suitable for assets that lose value
with time rather than usage, such as buildings or licenses.
The Unit Production Depreciation method is highly useful for depreciating assets where
wear and tear are closely linked to actual usage. This method allocates depreciation based
on the productivity of the asset, making it ideal for industries reliant on machinery, vehicles,
or other equipment that sees heavy use. While it may not be suited for all asset types, it
offers a highly accurate representation of depreciation for assets tied to production or
output. Project managers and accountants can apply this method to ensure a fair allocation
of depreciation costs over the asset's productive life.

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