The units of production method allocate the cost of depreciable assets over its usage rather than some passage of time. The method relates depreciation to the expected production capability of the depreciable asset. Useful life of a depreciable asset while using the units of production method expressed as total units of production or hours of work, but not as a passage of time as it is with other depreciation methods.
The units of production method might provide more accurate numbers while allocating a depreciable asset’s cost to the proper accounting period than the straight-line method would (which is based on the passage of time). This is mainly because, for example, even two same cars will wear out differently depending on its usage. Therefore, those autos should be depreciated accordingly to its activity. On the other hand, the different depreciation method (not the units of production) might be more appropriate if your vehicle is just staying in a garage for whatever reason. Even though, there is no activity, but the car is still constantly losing value and should be depreciated regardless of its usage.
Example of the units of production depreciation method calculation
To illustrate, let’s assume that an entity bought a car for $20,000 and no other cost is necessary to put it in use. The firm expects to drive it for 4 years and sell the auto for $4,000 at the end of it service life. During these 4 years of use, the company estimated to drive 100,000 miles in total on it.
Calculation of depreciation the asset by using the units of production method
|Years||Units of ativity (miles)||Initial cost||Salvage value||Depreciation base||Depreciation expense||Accumulated depreciation||Carrying value|
|A||B||C||D||E = C - D||F||G||H = C - G|
|1||30,000||$20,000||$4,000||$16,000||$4,800||(E / B5) x B1||$4,800||(F1)||$15,200|
|2||25,000||$20,000||$4,000||$16,000||$4,000||(E / B5) x B2||$8,800||(F1 + F2)||$11,200|
|3||25,000||$20,000||$4,000||$16,000||$4,000||(E / B5) x B3||$12,800||(F1 + F2 + F3)||$7,200|
|4||20,000||$20,000||$4,000||$16,000||$3,200||(E / B5) x B4||$16,000||(F1 + F2 + F3 +F4)||$4,000|
The first step in the depreciation calculation is to find the rate per unit or hour (which is fixed amount for all years of its useful life). In the given example the calculation will be based on miles driven during the years of service life of the asset.
Rate per unit (or hour) = (Initial cost – Salvage value) / Estimated units or hours
$0.16 = ($20,000 - $4,000) / 100,000 miles
Then the depreciation expense for a period can be found (this is variable amount and usually will differ from one period to the other)
Depreciation expense = Rate per unit (or hour) x # of units produced (or hours worked)
$4,800 = $0.16 x 30,000 miles (that were driven in the first year of the car service life)
Advantages of units of production depreciation method
- reflect more closely actual depreciation of assets with different levels of activity
- matches more accurately cost with revenue
- relates depreciation to activity of an depreciable asset
Disadvantages of units of production depreciation method
- if a depreciable asset has no activity, there won’t be any depreciation expensed regardless that machinery losing value making this accounting method unacceptable
- cannot be applied to all depreciable assets equally (items such as building or furniture which depreciation depends on passage of time)
- calculations can be complex if perform them manually