Depreciation is a portion of Company’s fixed assets considered as a decrease in value due to usage of asset.
This value is called depreciation expense. This does not require whether the asset is partially or fully used during the accounting period.
Methods for Calculating Depreciation Expense:
There are different methods used to calculate depreciation expenses by different organizations according to its policies. Some of methods are:
Because it provides a uniform expense throughout the life of an asset. But you can choose any of them according to your policy and business needs.
What is Units of Production Method?
Some organization prefer to calculate depreciation expense of their production noncurrent assets on their usage. Its means that their base is units produced by the plant instead of number of estimated useful life.
In this method the amount of depreciation expense is much higher in the period of heavy production compared to the periods of low production.
Formula to Calculate Units of Production Method:
In this method we use the units produced as the base price instead of estimated useful life.
The Salvage value is subtracted from the total cost of an asset and divided by estimated production capability. The result is then multiplying with Units per year.
Let have a look at the formula:
For further clarification have a look on the following example:
Company name ABC has the following data from the previous five years. You are required to calculate the depreciation on by using Units of Production Method.
The Production plant is purchase by the company from five years ago. At that time installation and purchase cost is $500,000. While the estimated salvage value at the end of its life will be $20,000.
|Years||Production In Units|
The estimated production capability at the time of purchase for this plant was 10,000,000.
For year 1 = [(500,000 – 20,000)/ 1,000,000] * 50,000
For year 2 = [(500,000 – 20,000)/ 1,000,000] * 30,000
For year 3 = [(500,000 – 20,000)/ 1,000,000] * 40,000
For year 4 = [(500,000 – 20,000)/ 1,000,000] * 70,000
For year 5 = [(500,000 – 20,000)/ 1,000,000] * 10,000
So if you analyses the above data it is proved that in the year 4 the production is the highest. And the depreciation expense is also the highest with an amount of 33,600.
While in the year 5 the production is at the lowest side with only 10,000 units to be produced. That’s why the depreciation expense is at the lowest side.
Outcomes of Units of Production Method:
In this method depreciation expense is act like variable expense. Which is fixed by units and change with the production.
This method helps the companies to adjust their depreciation expense according to seasonal affect.
The other benefit of this method is that the expense should be higher when wear and tear is high in the period. This method helps the seasonal companies to adjust their revenue and income according to the seasonal effect.
If they use the straight line method, they will have very high profits in the periods when production and sales were high but there will be low profits when the sales and productions were at the low side. Because in both the cases depreciation were charges at a fixed price.