UNITS OF PRODUCTION DEPRECIATION — MEANING, EXAMPLE, ADVANTAGES AND DISADVANTAGES

Units of output is a depreciation method where depreciation is calculated based on the actual usage of the asset.

It is a depreciation method based on the assumption that an asset will produce a fixed amount of output throughout its useful years and should, therefore, be depreciated according to the volume of output produced in a given accounting period.

To calculate the depreciation for each period in units of production depreciation, a company is expected to estimate the total units of production that an asset can produce throughout its useful life.

Depreciation expense in units of production method is made to vary with the units of output produced in each period of use.

The Units of production depreciation are also known as productive output depreciation, units of production depreciation, or units-of-output depreciation.

The units of production method of depreciation is mostly used when the loss of value of the asset is more closely tied to its users than the efflux of time.

An example of such an asset is a plant and machinery, which lose their value and efficiency as we used them.

The formula to calculate units of production depreciation is as follows.

$D.E=\frac{C- S}{U}\times A$

Where D.E is depreciation expenses

C is the cost of the asset

S is the scrap value of the asset

U is the total units of output to be produced over the useful years of the asset.

A is the actual units of production per year.

Example

James PLC buys a water machine costing N200,000. It is estimated that the machine can produce 400,000 bags of pure water over its useful life.

Also, the company expects to salvage the machine at 10,000 at the end of its useful life.

Assuming the farm only produce 30,000 bags of pure water this year, calculate the depreciation expense for using the unit of production method.

Solution;

$D.E=\frac{C- S}{U}\times A$

$D.E=\frac{200,000-10,000}{400,000}\times 30,000$

$D.E=\frac{190,000}{400,000}\times 30,000=14,250$

Advantages of Units of production depreciation

1. Match cost and benefits: More than any other method of depreciation, units of production appreciation match cost and benefits together.

This is because Units of production allocate costs based on the usage of the asset.

Therefore, unlike straight line depreciation, which allocates an asset's cost based on time even if the asset is kept, units of production allocate an asset's cost based on usage, which means the asset is not depreciated if it is kept idle.

2. It is very suitable for manufacturing businesses: This method of depreciation is very useful for manufacturing businesses because their income is based on the total units produced.

Hence, it may be unjustified to charge depreciation based on time (straight line depreciation) and not units of goods produced (units of production

3. Used to determine the efficiency of an asset: Units of production depreciation are based on the units of production of an asset.

Hence, it can be rightly used to determine the efficiency of an asset.

4. Useful for obtaining the depreciation per unit: Unlike other depreciation methods, units of production depreciation can be used to determine the depreciation expense per unit of production.

To calculate the depreciation cost per unit of production, the depreciable value is divided by the number of units expected to be produced by the asset during its useful life.

Disadvantages of Units of production depreciation

1. Does not consider other causes of depreciation: Units of production depreciation only considers depreciation due to usage of the asset.

In reality, however, assets do depreciate due to other factors including inadequacy, obsolescence, efflux of time etc. All of these factors are not considered by units of production depreciation.

2. Not suitable for all asset: Units of the production method of depreciation is not suitable for assets whose total units of output cannot be estimated at the time of acquisition.

More so, Units of production depreciation can only be used for manufacturing assets.

It cannot be used for assets such as buildings and furniture whose value is mostly dependent on the passage of time rather than on units of output produced.

3. It is very complex to calculate: Units of production are particularly challenging to calculate when a company has a lot of assets.

For example, if a company has a thousand assets, it will be very cumbersome to estimate the total output of the asset and record the output of each asset yearly.

Therefore, the unit of production depreciation may not be suitable for companies with a large number of assets.

4. Not advisable for tax purposes: Units of production depreciation are not recommended for tax purposes as most tax authorities do not accept it.

At such, It is only used for internal bookkeeping

5. Not suitable for all businesses: This method of depreciation is primarily used by manufacturing companies.

For some businesses like trading and service businesses, units of production depreciation should not be used.

Rather, such businesses should use straight-line depreciation or similar methods of depreciation.

Bottom line

Units of production depreciation (also known as units of output depreciation) should be used when the life of an asset is calculated based on output.

It shouldn't be used for assets not directly used in the manufacturing of goods and services.

Also, due to the fact that asset depreciation is influenced by other factors like efflux of time, care should be taken when using units of production depreciation.

Furthermore, since units of production are based on usage, the estimated total units of production of an asset throughout its useful life must be estimated appropriately to avoid charging more (or less) than necessary depreciation charges.

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