Unit of production method calculates depreciation charge on the basis of actual usage of asset. The expected total output, usually express in units produced or hours worked, is estimated at the time of acquisition and based on the activity in the period proportionate depreciation is calculated. Although the right name of method is unit of production but units of production is widely used.
Units of production method or allocates cost of asset on the basis of actual use of asset and thus matching the cost and benefits in a much better way than any other depreciation method. Straight-line method calculates depreciation on the basis of time and asset is depreciated even if it is idle. Same is the case with sum-of-years’-digits method. On the other hand declining balance method applies a consistent depreciation rate that may be more or less than actual wear and tear of asset. Unit of production method charges more depreciation to the period that benefited as asset was used more or for longer hours and charges less to the period in which asset wasn’t so active. This makes depreciation charge estimation much more logical and accurate.
Unit of production method uses the following formula to calculate depreciation:
|Depreciation for the period =||Output of current period||x||Cost – Residual value|
|Total expected output over useful life|
Example: Units of Production method of depreciation
Momhil Inc. bought a professional coffee machine costing $100,000. Over its useful life it is estimated that it can process 5,000 kgs of coffee or 200,000 servings. Entity can salvage the machine $5,000 at the end of useful life.
Calculate depreciation of Rotel for this year if entity is using unit of production method and it has:
- processed 200 kgs of coffee
- served 15,000 customers
1: Processed 200 kgs of coffee
With salvage value of 5,000 the depreciable value of machine is $95,000 (100,000 – 5,000). This year it has processed 200 kgs out of 5,000 kgs in total. The depreciation for this year is:
= 95,000 x 200/5,000
2: Served 15,000 customers
Depreciable value is same i.e. 95,000 (100,000 – 5,000). However, if entity is calculating depreciation on the basis of servings then relevant data will be used. This year 15,000 customers were served out of 200,000 in total, the depreciation for this year is:
= 95,000 x 15,000/200,000