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