Unit of Production Formula Definition
With time, the value of an asset depreciates. The method of calculating the asset’s depreciation cost over time is known as a unit of production.
Companies can use the unit of production method to develop an understanding of the higher depreciation expenses in the more productive years.
Benefits of Units of Production Formula
With the units of production formula, companies can decide the fixed asset cost based on its use. Here are the benefits of the unit of production method:
- Helps to determine the efficiency of an asset
- Does not charge unnecessary depreciation
- More accurate tracking of profit and loss
- Useful for manufacturing purposes
Applications of Unit of Production Method
The unit of production formula can be applied to assets whose value is closely related to the number of units it produces. Normally, you must choose assets that have wear and tear and depreciate with time. The two most suitable commodities you can apply to the unit of production method are machinery and plants.
Unit of Production Formula
Units of production formula = | (Original value – salvage value) ————————————— |
| total estimated production capability |
Salvage Value (S) = P (1 – i)y, where P is the asset’s original cost, i is the depreciation rate, and y is the number of years.
- Original cost caters to the cost price, delivery price, installation charge and incidental expenses.
- Estimated production capability is the unit produced by a product when it is useful.
Understand With an Example
For a better understanding, let’s consider an example here.
Suppose you purchased a TV on the 5th of January. Its cost price was AUD 50000 and had an estimated running time of 20000 hours.
In the first year, TV was used for only 4000 hours. Therefore, the salvage value becomes AUD 4000.
Thus,
Depreciation per unit (units of production)= (AUD 50000 – AUD 4000)/20000 hours
= AUD 2.3 per hour
With depreciation per unit cost, companies can easily calculate depreciation expense as well. For this, you have to calculate the year’s depreciation value based on the TV’s monthly depreciation rate.
Depreciation expense = 4000 hours x 2.3 per hour
Depreciation expense (total depreciation) = AUD 9200.
Value of the asset after depreciation = AUD 50000 – AUD 9200 = AUD 40800.
Inference
The unit of production formula can be applied to manufacturing assets with more production. With this method, you can keep track of the production and decide the fixed asset cost based on its use.