Assets that are used in high-volume production are subject to depreciation using this method. And in this approach, the amount of production is used to determine how much an asset will depreciate or be written off. In other words, this approach is preferable in situations where the asset’s life is primarily determined by the volume of its use or production. When production is high, there is a greater rate of depreciation, and vice versa. Users can quickly calculate depreciation using this method with the aid of a units of production depreciation calculator.
Only when the company anticipates a greater demand will it increase production. And as a result, the total sales volume and, consequently, the period’s revenue, will be higher. Depreciation should therefore be higher in the year with higher sales in order to match the revenues. We will be able to match the depreciation in proportion to the production volume using this method.
Units of Production Depreciation Method
How to calculate units of production depreciation
The units of production method can be used to determine the asset depreciation per accounting period as shown below:
1. Identify the assets original value
Calculate the original cost or purchase price of an asset to determine its original value before depreciation. Any asset you own for your business or other income-generating activities that has the potential to gradually deteriorate over the course of its useful life is a depreciable asset. An income-producing asset’s value frequently decreases over time from its original value with continued use.
2. Determine the salvage value
Salvage value is the estimated value of an asset at the end of its useful life. You can estimate salvage value by making a knowledgeable projection about what you anticipate the asset to be worth when it degrades. You can also conduct some research or ask around to find out how much your asset might be worth after it has degraded beyond repair. According to market research on excavators, a construction company might anticipate that a brand-new excavator will be worth $15,000 when it reaches the end of its useful life.
3. Determine the estimated production capability
When estimating production capacity, consider how many units or items an asset will likely produce over the course of its useful life. This number may represent the number of units produced, the amount of accumulated gas mileage, or the number of hours the asset was used, depending on the asset.
A plumber, for instance, might determine that a service vehicle’s useful life is 200,000 miles of total driving before it needs to be replaced. The vehicles’ estimated production capacity in this instance is 200,000 miles. By conducting research or asking questions about the maximum capacity of their assets, asset owners can determine the estimated production capability of their assets.
4. Identify units per accounting period
Determine the units per accounting period for your depreciable asset. When calculating the depreciation of an asset, you can take into account the number of units it produces during a given accounting period. Although many businesses use an annual period, the company can define its accounting period as any period of time.
5. Calculate the units of production depreciation
Compile information on the asset’s original value, salvage value, estimated production capacity, and units per accounting period. The formula below can be used to calculate the accounting periods depreciation once all the variables have been identified:
Production depreciation units are calculated as follows: units per accounting period = [(original value – salvage value) / estimated production capability]
What is the units of production method?
A mechanism that enables companies or self-employed people to estimate the value of their income-producing assets before the assets depreciate is the units of production method, also known as the units of activity method and the units of usage method. By comparing an asset’s original value to its anticipated depreciation, the units of production method can determine depreciation. When an asset is something that is used extensively over a long period of time, business asset owners can benefit from using this depreciation method.
To determine the depreciation of assets used by your business, such as machines, vehicles, and equipment, you can use the units of production method. For bookkeeping and tracking operating costs, a company or independent contractor could calculate depreciation on company assets. When filing taxes, asset owners can deduct depreciation on their income-generating assets and calculate their business depreciation tax deduction using the units of production method.
Example of units of production depreciation calculations
An illustration of how to calculate units of production depreciation is provided below:
A wide-format printer costs $7,500 for a large printing business. The company calculates that the printer has a salvage value of $1,200 and a useful life of 500,000 high-quality printouts. The company prints 25,000 pages from the wide-format printer in its first year of operation. The wide-format printer’s annual depreciation can be calculated using the units of production method by the company, which uses an annual accounting period:
Production depreciation units are calculated as follows: units per accounting period = [(original value – salvage value) / estimated production capability]
Depreciation on production units is calculated as follows: [($7,500 – $1,200) / 500,000 pages] x 25,000 pages = $315.
Applying the formula, the company discovers that the wide-format printer’s depreciation in its first year of use is $315. This $315 asset depreciation is a cost of doing business for the company. When filing its yearly taxes, the company may deduct $315 for depreciation. If the wide-format printer keeps printing at a rate of 25,000 pages per year, the company can also predict that its useful life will be 20 years.
Other depreciation methods
There are some depreciable assets, such as intangible ones like patents and copyrights, that may have depreciable costs that call for a different calculation method than the units of production method. Here are additional depreciation methods you can consider:
FAQ
What is depreciation per unit?
- This method only considers usage to calculate depreciation. …
- Often this method might not be practical. …
- The two identical assets’ book value and depreciation values could differ as a result of this method.
- The unit of production depreciation is not recommended for tax purposes.
Which is an example of units of production?
Is depreciation a production expense?
For instance, a machine can produce 1000000 meters of cloth over the course of its useful life. So it is advised to use the units of production method here. Divide the asset’s total depreciable amount by the estimated annual total production in units to determine the amount of depreciation.
Why would a company use the units of production method for depreciation?
Depreciation expense is regarded as an indirect cost in the production department of a manufacturing company because it is added to factory overhead and then allocated to the units produced over the course of a reporting period. The most typical treatment in a business is to count depreciation as an indirect cost.
