Property, Plant, & Equipment

Dr. Jacqueline Gagnon

11 Property, Plant, & Equipment

Value-Creating Assets

Method 3: Units of Production

A lightbulb brain in a circle—the 'think' section of the think-see-do approach.

Units of production is a bit different. This depreciation method is calculated similarly to straight-line depreciation, except that the useful life is in units rather than years. Specifically:

$\begin{equation*} \text{Depreciation}\;=\;\frac{\text{Cost}\;-\;\text{Residual Value}}{\text{Total Units Produced}}\;\times\;{\text{Units in}\atop\text{Current Period}} \end{equation*}$

Units produced may be kilometers driven, units of inventory produced, number of hours used, etc. Why would we use units of production to calculate depreciation? Well maybe the asset’s value decreased through wear and tear as we use it. Remember that we prorated the first year, meaning that we divided the depreciation in half, for straight-line and declining balance methods? We won’t prorate for units of production. Why not? Proration reflects the fact that an asset has not been in use for the entire year. But the proration is already done for us through the units produced in the first year. Let’s say that the company ordinarily produces 60,000 units per year, but they bought their production equipment in September. If the company has a December year end, they will likely only produce 20,000 units in the first year (60,000 units x 4/12 months). See, the proration is done for us because the company will naturally have less output in the first year.

An eye in a circle—the 'see' section of the think-see-do approach.

Let’s look at Jody’s Joinery, Flo’s Flowers, and Ryder’s Motorsport again, this time using units of production method for depreciation.

My Turn:: Jody’s Joinery (equipment cost = $49,240; estimate units to be produced = 1,800,000 inventory units; residual value = $5,000): With the new welding equipment Jody produces 50,000 units in 20X1 and 120,000 units in 20X2.
Required:: record depreciation on the welding equipment at 31 Dec 20X1 and 31 Dec 20X2. What is the Statement of Financial Position presentation at 31 December 20X2? That is, after two years of depreciation.

(1) $\begin{align*} \text{Depreciation}\;&=\;\frac{\text{Cost}\;-\;\text{Residual Value}}{\text{Total units produced}}\;\times\;\text{Units} \\ \, \\ &=\;\frac{\$\,49,240\;-\;\$\,5,000}{1,800,000}\;\times\;50,000 \\\\\ \text{Depreciation}\;&=\;\text{\$1,229} \end{align*}$