Definition
The Production-Unit Method (also known as the Units of Production Method of Depreciation) is a technique for calculating the depreciation charge for machinery or equipment. Unlike other methods such as the [straight-line method] that consider depreciation as a [fixed cost], the production-unit method views it as a [variable cost]. In this method, depreciation is tied directly to the machinery’s output—i.e., the number of units the machine produces over its lifetime.
Formula
The depreciation charge per unit is calculated using the following formula:
\[ \text{Depreciation per Unit} = \frac{\text{Cost of Asset} - \text{Salvage Value}}{\text{Total Estimated Production Units}} \]
The resulting per-unit depreciation is then multiplied by the actual number of units produced during each period to derive the depreciation expense.
Examples
Example 1: Factory Equipment
A piece of factory equipment is purchased for $100,000, with an estimated salvage value of $10,000. The equipment is expected to produce 900,000 units over its lifetime. The depreciation per unit is calculated as follows:
\[ \text{Depreciation per Unit} = \frac{100,000 - 10,000}{900,000} = 0.1 \]
If the equipment produces 90,000 units in a given year, the depreciation expense for that year would be:
\[ \text{Depreciation Expense} = 0.1 \times 90,000 = 9,000 \]
Example 2: Printing Press
A printing press is bought for $50,000 with a salvage value of $5,000. It is expected to print 500,000 books during its lifetime. The depreciation per book is:
\[ \text{Depreciation per Book} = \frac{50,000 - 5,000}{500,000} = 0.09 \]
If the press prints 100,000 books in a year, the annual depreciation expense would be:
\[ \text{Depreciation Expense} = 0.09 \times 100,000 = 9,000 \]
Frequently Asked Questions (FAQs)
1. What types of assets are best suited for the production-unit method of depreciation?
Assets whose wear and tear significantly depend on their use, such as machinery, vehicles, or manufacturing equipment, are best suited for this method.
2. How often should the total estimated production be revised?
The total estimated production should be revised if it becomes apparent that the initial estimate was inaccurate. Any changes will affect future depreciation calculations.
3. Is it possible to use the production-unit method for tax purposes?
Yes, many tax authorities allow the use of the production-unit method for tax purposes, but it is important to adhere to your local tax laws and guidelines.
4. How does the production-unit method differ from the straight-line method?
While the production-unit method calculates depreciation based on actual usage, the straight-line method spreads the cost evenly over the asset’s useful life.
5. Does the production-unit method require complex calculations?
Not necessarily. The key is to have accurate records of total production units and annual production, which can make the calculations straightforward.
Related Terms
Depreciation
A method used to allocate the cost of a tangible asset over its useful life.
Fixed Cost
Expenses that do not change with the amount of goods or services produced.
Variable Cost
Expenses that vary directly with the level of production.
Straight-Line Method
A common method of depreciation where the expense is spread evenly over the useful life of the asset.
Salvage Value
The estimated residual value of an asset at the end of its useful life.
Online References
Suggested Books for Further Studies
- “Financial Accounting: An Introduction to Concepts, Methods and Uses” by Clyde P. Stickney and Roman L. Weil
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Accounting for Dummies” by John A. Tracy
Accounting Basics: “Units of Production Method of Depreciation” Fundamentals Quiz
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