MACHINE HOUR RATE DEPRECIATION— MEANING, EXAMPLE, ADVANTAGES AND DISADVANTAGES

Machine hour rate depreciation is a form of depreciation where an asset is depreciated based on its service hour.

In machine hour rate depreciation, the useful life of an asset is calculated based on the working hours of the asset, rather than the number of output produced.

Therefore, to calculate the machine hour rate depreciation, the running time (or the working hours) of an asset have to be known.

One unique feature of machine hour rate depreciation is that the useful life of an asset is expressed in working hours rather than numbers of years.

Machine hour rate depreciation is very useful for depreciating assets such as plants and machinery which are directly used for the production of goods and services.

Machine hour depreciation is sometimes called service hour depreciation.

The annual depreciation expense for machine hour depreciation can be calculated as follows:

$D=\frac{C-S}{W}×A$

Where D is depreciation expenses

C is the cost of the asset

S is the salvage value of an asset

W is the estimated total working hours of an asset over its useful life

A is the actual working hour of an asset 

Example

James PLC bought machinery for N40,000. It is estimated that the machine will have an estimated useful life of 3800 hours.

Furthermore, the company expects to salvage the machine at N2000.

Calculate the depreciation expense for the second year, assuming the company only used the machine for 980 hours

Solution:

Recall that $D=\frac{C-S}{W}×A$

$D=\frac{40,000-2,000}{3800}×980$

$D=\frac{38,000}{3800}×980=N9800$

READ ALSO: UNITS OF PRODUCTION DEPRECIATION

Advantages of machine hour rate depreciation

1. It can be used to know the idleness of an asset: machine hour depreciation is based on the working hours of an asset.

This makes it very suitable for pinpointing the degree of idleness of an asset.

2. Suitable for businesses that rely heavily on machines: Machine hour rate depreciation is very suitable for companies where most of the jobs are done by machines rather than humans.

3. It can be used for comparison: Because machine hour rate depreciation is based on usage, it is very helpful for comparing the relative efficiency of various assets.

4. Use to gauge the relative importance of machines: Machine hour depreciation can be used to measure the relative importance of machines to manual labour.

A high number of hours of machine usage can tell a company that its production is highly dependent on machines.

5. Useful for determining the depreciation per hour: Machine hour depreciation is very useful for determining the depreciation expenses per hour of usage.

To calculate the depreciation expense per hour of usage, we divide the depreciable value by the estimated total working hours of the assets

READ ALSO: SUM OF THE YEARS' DIGIT DEPRECIATION

Disadvantages of machine hour rate depreciation

1. It is very cumbersome to calculate: Machine hour rate depreciation is very cumbersome to calculate especially if the company has a lot of machines.

For example, if a company has a thousand machines, it will be very stressful and cumbersome to keep track of the working hours of each one.

2. Ignores other factors: Machine hour depreciation does not consider other factors like efflux of time, or inadequacy that cause depreciation.

It only considers depreciation due to usage.

3. Not useful for all assets: Machine hour rate depreciation is not suitable for every asset.

Machine hour rate depreciation cannot be used to calculate the depreciation on assets like buildings and furnishings that aren't directly involved in the creation of goods and services or whose total usage working hours cannot be determined 

This is because such asset depreciation is more related to efflux of time than usage.

4. Difficulty in estimating hours of usage: It can be very difficult to predict how many hours an asset will be used in total throughout its lifetime.

This is especially true when the production program of the asset is not known in advance as at the time of acquisition.

5. Not suitable for labour-intensive firms: It is not recommended to use machine hour rate depreciation if a large number of the production of a firm is done by manual labour, rather than a machine.

Simply said, machine hour rate depreciation should not be used if the manpower requirement is more than the machine requirement.

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