Units of Production Method: Depreciation Simplified

Commerce

Units of Production Method: Depreciation Simplified

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Units of Production Depreciation Method

Depreciation refers to the decrease in the assets value because of the effect of time, wear and tear, obsolescence because of advancements in technology, etc. Depreciation also comprises amortization. The Units of Production Depreciation Method, also known as the Units of Output Method, plays an important role to determine the charges on the assets depreciation.

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Units of Production Depreciation Formula

The method to charge depreciation on the assets depends on the number of units that are produced throughout the year. The criteria to provide depreciation is the total estimated cost of the production. This is applied when the total equivalent units of production are equal to the value of the asset. Hence, during the years when there is a higher usage of the asset, the depreciation amount is high. Plants and machinery are some of the common assets on which this method is implemented.

Consider, for example, that a given machine has a total capacity for producing 10,00,000 meters cloth during its lifetime. Then in this case it is essential to follow the units of production depreciation method.

The total depreciation amount for a year is determined when the total depreciable amount of the asset is divided by the estimated total production multiplied by the units. This figure is then multiplied by the total number of units that have been produced in the year.

The Units of Production Method Formula is given by

Annual Depreciation = Depreciable Value x \[\frac{\text{Units produced during the year}}{\text{Estimated total production}}\]

The Depreciable value = Original cost - Scrap value

Solved Example to Calculate Units Of Production Depreciation

Example:

A textile company bought machinery for ₹2,00,000 on the 1st of January that has an approximate 10 years of useful life and about ₹20,000 estimated residential value. The asset is sold by the firm at its residential value during the end of 10th year. The expected production units of the machinery is 15,000 during the course of its useful life. The current production pattern of the machinery is:

Year	Production
1-3	2,000 units per year
4-7	1,500 units per year
8-10	1,000 units per year

Determine the Total Amount of Depreciation with the Help of the Units of Production Method. Pass the Required Entries of the Journal and Prepare the Machinery A/c.

Solution:

Calculation of Depreciation With the Help of the Units of Production Method:

Depreciable Value = Original cost – Scrap value

= 2,00,000 - 20,000

= 1,80,000

The Units of Production Method Formula is given by

Annual Depreciation= Depreciable Value х (Units produced During the Year)/(Estimated Total Production)

Year	Annual Depreciation
1-3	1,80,000 x 2,000/15,000 = 24,000
4-7	1,80,000 x 1,500/15,000 = 18,000
8-10	1,80,000 x 1,500/ 15,000 = 12,000

Journal Entry in the Books of the Textiles Industry is as Follows:

Date	Particulars		Amount (Dr.)	Amount (Cr.)
1st year
1-1	Machinery A/c	Dr.	2,00,000
	To Cash A/c			2,00,000
	(Being machinery purchased)
1st – 3rd year
31 Dec	Depreciation on Machinery A/c	Dr.	72,000
	(24,000 x 3)
	To Machinery A/c			72,000
31 Dec	Profit & Loss A/c	Dr.	72,000
	To Depreciation on Machinery A/c			72,000
4th – 7th year
31 Dec	Depreciation on Machinery A/c	Dr.	72,000
	(18,000 x 4)
	To Machinery A/c			72,000
	(Being depreciation charged on machinery)
31 Dec	Profit & Loss A/c	Dr.	72,000
	To Depreciation on Machinery A/c			72,000
8th –10th year
31 Dec	Depreciation on Machinery A/c	Dr.	48,000
	(12,000 x 3)
	To Machinery A/c			48,000
	(Being depreciation charged on machinery)
31 Dec	Profit & Loss A/c	Dr.	48,000
	To Depreciation on Machinery A/c			48,000
10th year
31 Dec	Cash A/c	Dr.	20,000
	To Machinery A/c			20,000
	(Being machinery sold)
31 Dec	Machinery A/c	Dr.	12,000
	To Profit & Loss A/c			12,000

FAQs on Units of Production Method: Depreciation Simplified

1. What is the Units of Production Formula?

Ans: The units of production method determines that the useful life of an asset is closely related to the asset’s usage and not just the passage of time. In the units of production depreciation method, the amount of depreciation in a year is higher when the volume of activity is higher. The depreciation value of the asset would be lesser when there would be lesser usage.

This method leads to higher deductions being considered in the depreciation years whenever the asset has been in a heavy usage. This offsets the periods when the asset is a lesser usage.

The Depreciation per Unit Formula is given by

Annual Depreciation = Depreciable Value х (Units produced during the year)/(Estimated total production)

2. What is the Difference Between the Unit of Production Method and the MACRS Method?

Ans: The MACRS or Modified Accelerated Cost Recovery System is a standardized method for depreciating assets for taxes. This method includes calculations which lead to the value of the asset being depreciated with a declining balance over a period of time and not just being dependent on the total number of units that the asset would produce. The asset value then switches to a straight line method of depreciation for finishing the schedule of depreciation.

The IRS needs businesses to depreciate their asset with the help of MACRS for tax purposes, however, it allows them to exclude the asset in case they can be calculated accurately by the units of production method. For using this method of units of production, the business owner has to elect to exclude from MACRS within the due date of the return for the tax.