UNITS OF PRODUCTION Method of Depreciation - YouTube

Hey there, I'm James you're watching Accounting Stuff

and in this video you'll find out how to calculate depreciation using the

Units of Production Method Depreciation is the process of

reducing the book value of a tangible fixed asset due to use

wear and tear the passing of time

or obsolescence The Units of Production method of

depreciation is a variable cost depreciation method where expenses

mirror the actual physical use of the asset

Picture this...

One day you decide to make the move to the Pacific coast of Canada

there are more trees here than you could ever imagine and being an enterprising

young person you decide to open up a sawmill So you secure location and buy

your first sawmill machine it costs you $10,000

Your sawmill machine is a tangible fixed asset

it's tangible because you can touch it and it's fixed because you plan to use it

for a long time This one can produce 150,000 units of timber

and after that it will be worth $1,000 in scrap

Let's depreciate it using the Units of Production method

Step 1 Write down what you know

Your asset is a sawmill machine and we're going to use the

Units of Production method of depreciation The asset cost is $10,000

it's residual value is $1,000 and we expect it to be

useful for 150,000 units We'll calculate the depreciation per unit

and depreciable cost in Step 3

Step 2

Build a depreciation schedule A depreciation schedule is a table

and in the units of production method it has six columns

We have…

Year opening book value

number of units produced depreciation expense

accumulated depreciation and closing book value

The number of units produced is an extra column that we include

for the Units of Production method we need to track this period by period

to help us work out your depreciation expense

Step 3

Calculate the depreciation expense accumulated depreciation

and book values for each period Now it's time for us to

fill out the schedule and we'll start with year one

which is the first accounting period You're opening book value is the

carrying amount of your sawmill machine at the start of the year

and in year one this is $10,000 the same as your asset cost

Your business carefully records the number of units produced

and it turns out that in year one that was 18,000 units of timber

Now your depreciation expense is your depreciation per unit

multiplied by your number of units produced

We can work out your depreciation per unit by taking

your depreciable cost and dividing it by the total useful units

What is depreciable cost?

It’s your asset cost minus residual value it represents the portion of your

sawmill machine that will depreciate over its useful life time

Your asset cost is $10,000 and it's residual value is $1,000

so your depreciable cost is the difference of $9,000

We said that your sawmill machine can produce 150,000 useful units

so your depreciation per unit is $9,000 divided by 150,000 units

which comes to $0.06 or Six Cents per unit

By the way depreciation per unit is very similar to the depreciation rate

that we discussed in my other videos but depreciation per unit is expressed

as a cost per unit whereas depreciation rate is a

fraction of an assets useful life As usual you can find this formula

on my depreciation cheat sheet and I'll drop links to that and

the whole depreciation playlist down in the description

Anyway we can now calculate your depreciation expense this is your

depreciation per unit multiplied by the number of units produced

You produced 18,000 units in year one so if we multiply that by

Six Cents per unit then you've got a depreciation expense of $1,080

this is the amount of your sawmill machine that you’ll write off

to your income statement Here's another thing to bear in mind

your depreciation per unit is constant but your number of units produced

will change each year So your depreciation expense under

the Units of Production method is going to be a variable cost

to your income statement it’s going to mirror your

actual physical use of the asset Accumulated depreciation is the

cumulative total of all depreciation expenses incurred

In your first accounting period it'll match your depreciation expense

Your closing book value is the carrying amount of your sawmill machine

in your balance sheet at the end of the year It’s your opening book value of $10,000

minus your depreciation expense of $1,080 which is $8,920

This then becomes your opening book value for year two

Let's say it's a slow year and you only manage to produce 13,000 units

of timber this time around Again your depreciation expense

is the depreciation per unit multiplied by your number of the units produced

Depreciation per unit is a constant Six Cents per unit

and you produced 13,000 units So your depreciation expense is

Six Cents per unit multiplied by 13,000 which is $780

Your accumulated depreciation is the cumulative total of $1,860

and your closing book value is your opening book value of $8,920 minus

your depreciation expense of $780 which is $8,140

If we repeat this process for the next few years then this is what we're left with

Notice that your depreciation expense changes each year in proportion to the

number of units you produced We can see this better on the graph

This shows your sawmill machine's book value over time

Your asset cost is $10,000 its residual value it's $1,000

and your depreciable cost is the difference of $9,000

Under the Units of Production method your depreciation expense is variable

because it changes each year mirroring your actual physical use of the asset

I outline of all of this on my depreciation cheat sheet

which you can find over here and if you missed out on any of

my other depreciation videos have no fear there in this playlist right here

See you next time