Units of Production Method: Explanation, Formula, and Solved Example

Unlike straight line units of production or units of output are alternative terms for the and double declining depreciation methods, units of production depreciation method is not based on a consistent percentage or table. Some years the asset will be used more while some years the asset will be used less. The units of production method, also known as the units of activity method, is a common approach to calculating depreciation for fixed assets that a company intends to use for more than a year. Depreciation allows businesses to allocate the cost of an asset over its useful life, reflecting the asset’s consumption and wear over time. This method is particularly useful when the asset’s usage can be measured in terms of output rather than time.

Straight-Line Method of Depreciation Calculation

The units of production depreciation method is more cumbersome to calculate than most of the other depreciation methods. You have to adjust the calculation from one period to the next based on the asset’s usage, meaning you can’t set up an automatically posting depreciation entry in your accounting software. Units of production depreciation is one of four types of depreciation you can use for managerial accounting purposes. This depreciation method helps you calculate how to reduce the value of a fixed asset in your business based on the number of units it produces in a given period of time. The unit of production method plays a vital role in the calculation of depreciation of assets owned by a company. For specific years in which an asset is put into use and have more unit productions, a company can claim higher depreciation deductions.

Units of Production Depreciation Formula

The Corporate Finance Institute explains that the straight-line depreciation method is simple to calculate because it allocates the same depreciation expense for each accounting period. So there is little room for error when accounting for the depreciation expense. The unit of production method is commonly used in manufacturing companies.

• Rather than depreciating over a number of years, the asset depreciates after it’s been used a certain number of times, referred to as units of production.
• Another method commonly used for depreciation is the modified accelerated cost recovery system (MACRS).
• While more accurate in theory, the units of production method is more tedious and requires closely tracking the usage of the fixed asset.
• As discussed earlier, that unit of production method cannot be used for tax purposes.

Depreciation: Units-of-Activity: Videos & Practice Problems

• Under the unit of production method, it is expected that the machine will produce 20,000 units during its useful life.
• The companies working in the industries having seasonal demand can use the unit of production method.
• They will also reduce the book value of your assets on your balance sheet by the same amount.
• The units of production rate is equal to the depreciable fixed asset carrying value (i.e. the cost basis net of the salvage value assumption) divided by the estimated number of production numbers, which comes out to $0.50.
• The modified accelerated cost recovery system (MACRS) is a standard way to depreciate assets for tax purposes.

This method leads to higher deductions being considered in the depreciation years whenever the asset has been https://www.bookstime.com/articles/top-highest-paying-jobs in a heavy usage. At the end of fiscal year 2020, the company purchased a fixed asset, i.e. capital expenditure (Capex), for $250 million. Notice we don’t change the value of the WidgetMaker 3000 itself; instead, the reduction of the asset’s value is reflected by a negative amount in accumulated depreciation for the asset. This method effectively allocates the asset’s cost over its productive capacity. This brings the accumulated depreciation to $40,000, aligning with the depreciable base of $40,000 ($42,000 cost – $2,000 residual value).

• The Unit of Production Method is a depreciation method that measures the depreciation of an asset based on its usage and not just passage of time.
• The actual terms of trade are 1 unit of apparel for 1½ units of chemicals and that 4000 units of apparel are exchanged for 6 tons of chemicals.
• At the end of fiscal year 2020, the company purchased a fixed asset, i.e. capital expenditure (Capex), for $250 million.
• For example, the factory robot that starts life at $1 million may be expected to produce 900,000 total units of hubcaps before reaching the end of its useful life and being sold for scrap at $100,000.
• Will specialize in the production of chemicals as it has a lower opportunity cost.
• Also, the straight-line method ignores the higher maintenance costs of the asset towards the last few years of its useful life.

Plants and machinery are some of the common assets on which this method is implemented. In Step 1, we determined the units of production rate for your WidgetMaker 3000 was $0.10/Widget. To arrive at the depreciation expense, we will multiply the number of Widgets produced each month by $0.10 to arrive at the depreciation expense for the month.

Different Methods for Different Assets

In some cases, the residual value may be zero because the item is assumed to be worthless at the end of its natural life. For example, a piece of computer spreadsheet software worth $99 at purchase may be obsolete after a three-year useful life. In that case, the calculation is the same, with the software depreciating by $33 each year and worth $66 after one year, $33 after two years and $0 after three years. You can find the accumulated depreciation by adding up the depreciation per year for the number of years you are interested in. Each Widget you produce using your WidgetMaker 3000 reduces the value of the machine by $0.10.

This method is particularly useful for manufacturing equipment, vehicles, and other assets where usage varies significantly over time. In many manufacturing industries, the assets are depreciated not based on their useful life. It is done by estimating the output from the asset over the useful fixed assets life. For example, the factory robot that starts life at $1 million may be expected to produce 900,000 total units of hubcaps before reaching the end of its useful life and being sold for scrap at $100,000.