A units of a production method of depreciation provides for the accrual of depreciation in proportion to the volume of work performed, the output of products (units of products) and establishes the ratio of the purchase value of an asset (minus its residual value) with a certain volume of products produced.
This method is based on the assumption that the actual income received from the usage of the relevant asset in each reporting period is associated with the release of units of products produced with its involvement in these accounting periods.
Many believe that a type of equipment such as a machine should be depreciated for accounting purposes in proportion to the units produced on it during each reporting period (based on a predetermined total output), and not just in proportion to the time since the beginning of the operation. They argue that most production assets contribute to income (and therefore wear out) only when they are used in production, not just over time.
Advantages and disadvantages
The advantages of this method are simplicity, rationality, and consistency. The latter provides a better level of consistency in terms of the amount of depreciation, which is recognized as an expense in the current period with the income received if the use of the corresponding asset is not the same in different periods.
However, despite the advantages, the units of production method has not received widespread use, since it is impossible or very difficult to determine the actual volume of products produced using a particular asset. The disadvantages of the method are its difficulty and limitations.
It is better to use this method of depreciation in proportion to production output when, relative to the asset for which the depreciation is calculated, it is possible to determine the actual volume of production (work performed). The use of this method is also advisable when the economic usefulness of an asset diminishes due to use in production rather than just the passage of time.
With the units of production method, you look at depreciation expense in units. The formula for calculating the amount of this expense is not much more complicated than the simple straight-line depreciation. You would take the cost of the item you are depreciating and subtract the salvage value. Then, you simply need to divide that number by the activity consumption. You probably know what a salvage value is, but what is meant by activity consumption? Let’s take a look at an example.
You buy a laser printer that costs you $500 and the manufacturer states that you can print a maximum of 50K pages using the printer. The life of the printer is expected to be 3 years and it has a salvage value of $50. The number of pages the printer can make represents the activity for the unit you measure. In other words, this is its life in pages.
Now, let’s input the numbers into the formula – ($500 – $50) / 50K. This gives you $0.009, which is the cost per one printed page. Now, let’s assume that during the first year, you printed 30K pages on your laser printer. What is your printer depreciation expense? To get the answer, you will simply multiply $0.009 by 30K to get $270, which is the amount you can write off in your bookkeeping records.
As you can see, the units of the production method of depreciation calculation is very simple if you know the exact number of units a particular asset can make and can track down how many units were made using the machine you want to calculate the depreciation for.