Units of Production Method of Depreciation
The decrease in the value of the asset over its life is known as depreciation. This is the basic definition of the depreciation. Depreciation of an asset can be calculated in many different ways.
As it is not required by the GAAP or IFRS to use a single depreciation method for all the assets of the company, it is on the judgment of the company to select the method of its choice. It is also not mandatory to select only one depreciation method for all the assets, although it is necessary to select a method that will decrease the value of the asset in the proper manner. Following are some of the depreciation methods that are generally used by the business to calculate the decrease in the value of the assets:
- Straight-line depreciation
- Reducing balance depreciation
- Sum-of-years’ digit method
- Unit of production depreciation
Unit of production depreciation method
This method of depreciation is different from the other method that reduces the life of an asset based on the numbers of years it has left as its useful life. In the unit of production depreciation, as the name suggests, the depreciation of the assets is based on the number of units it produces rather than the number of years of useful life left. Due to the depreciation calculation based on its activity, this method is also sometimes referred to as units of activity method. Simply put, in this method of depreciation, the useful life of assets depends on its productivity and its ability to produce the total number of units.
The formula of this method is as follows:
Annual Depreciation Expenses = (Cost of Fixed Assets – Residual Value)/Estimated Total Production * Actual Production
The scrap value or residual value of an asset is deducted from the cost of the asset and instead of dividing it with the useful life; it is divided by the number of the units the asset is supposed to produce. The answer is divided by the actual production of the asset and these results in the providing the depreciation charge of the current year.
The companies halt the process of calculating depreciation when the net book value of the asset becomes equal to the scrap value. The accumulated depreciation over the life of the asset plus residual value is equal to original cost.