How to Calculate Units of Activity or Units of Production Depreciation

20 Feb How to Calculate Units of Activity or Units of Production Depreciation

The output level from any asset directly relates to the expenses incurred in production. The profitability levels fluctuate with different levels of the activities too. As with activity-based costing, https://turbo-tax.org/innovative-tax-relief/ the depreciation method connects the profitability with asset activities. The yearly profits and costs can be really spread out based on the actual performance and utility of the underlying assets.

• ¨ It is important for companies to (1) keep assets

  in good operating condition, (2) replace worn-out or outdated assets, and (3)

  expand its productive assets as needed.

• However, the depreciation will stop when the asset’s book value is equal to the estimated salvage value.
• Units-of-activity is a depreciation technique in which useful life is expressed as a percentage of total units of production or use expected from an asset rather than a time period.
• ¨ Cost

  consists of all expenditures necessary to acquire an asset and make it ready

  for its intended use.

The unit of production or activity-based method results in varying depreciation amounts over the useful life of the assets. Some seasonal demands for higher productions can also affect the output units, hence affecting the depreciation amount charged. ¨ Under the units-of-activity method,

useful life is expressed in terms of the total units of production or use

expected from the asset. The asset depreciation for an accounting period is based on the level of activity in that accounting period. Activity units can be defined in any number of ways to suit the asset and the business, such as number of hours used, or number of miles driven. The unit of production method depreciation begins when an asset begins to produce units.

Unit-level activity definition

¨ The retirement of an asset is recorded by

decreasing Accumulated Depreciation for the full amount of depreciation taken

over the life of the asset. ¨ Straight-line depreciation is the most widely

used method of depreciation. ¨ It is important for companies to (1) keep assets

in good operating condition, (2) replace worn-out or outdated assets, and (3)

expand its productive assets as needed. ¨ Plant

assets are resources that have physical substance (a definite size and

shape), are used in the operations of a business, and are not intended for sale

to customers. V     

Indicate how long-lived assets are reported on

the balance sheet. V     

Identify the basic issues related to reporting

intangible assets.

• It becomes useful when an asset’s value is more closely related to the number of units it produces rather than the number of years it is in use.
• ¨ Cost is measured by the cash paid in a cash

  transaction or by the cash equivalent

  price paid when noncash assets are used in payment.

• In DDB depreciation the asset’s estimated salvage value is initially ignored in the calculations.
• He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own.
• In the U.S. companies are permitted to use straight-line depreciation on their income statements while using accelerated depreciation on their income tax returns.

In the last year of depreciation, we throw out the formula and simply plug in the number that gets us to our salvage value.

Depreciation cost $____ per

By the total number of units produced by the asset over its estimated useful life Then you multiply the unit cost rate by the number of units produced during the period. The unit of production method is a method of calculating the depreciation of the value of an asset over time. It becomes useful when an asset’s value is more closely related to the number of units it produces rather than the number of years it is in use. This method often results in greater deductions being taken for depreciation in years when the asset is heavily used, which can then offset periods when the equipment experiences less use.

¨ The choice of depreciation method must be

disclosed in a company’s financial statements. The disclosure is found in the notes that accompany the statements. ¨ Recognizing

depreciation for an asset does not result in the accumulation of cash for

replacement of the asset.

How to Calculate Straight Line Depreciation

As in activity-based costing, the Activity depreciation method changes the cost behavior with the fluctuating output. In many production facilities, businesses have to manage additional costs after an increased volume such as additional labor, supervisors, and energy costs, etc. The Activity-Based Depreciation allows businesses to recover higher costs when the production levels increase after a certain limit.

This differs from other depreciation methods where an asset’s depreciable cost is used. To introduce the concept of the units-of-activity method, let’s assume that a service business purchases unique equipment at a cost of $20,000. Over the equipment’s useful life, the business estimates that the equipment will produce 5,000 valuable items. Assuming there is no salvage value for the equipment, the business will report $4 ($20,000/5,000 items) of depreciation expense for each item produced. If 80 items were produced during the first month of the equipment’s use, the depreciation expense for the month will be $320 (80 items X $4). If in the next month only 10 items are produced by the equipment, only $40 (10 items X $4) of depreciation will be reported.