The units of production method most accurately indicates the use of an asset because it tracks usage based upon activity rather than simply the passage of time.
The formula for units of production is similar to the formula for straight-line:
Because depreciation expense is based on the actual usage during the period, the purchase date is irrelevant!
Not all estimated lives are based on the same type of usage. For example,
On January 1, 2017, your company purchased machinery for $50,000 cash. You've estimated that the machinery will last 20,000 machine hours over five years (estimated useful life). You've also estimated that the residual value of the machine at the end of the 20,000 machine hours will be $5,000. Calculate the depreciation expense, accumulated depreciation, and book value for each year during the five-year useful life of the asset and record the adjusting entry for 2017.
For this method, you would need to know the actual machine hours for the asset over its useful life. The actual machine hours for the asset are listed below:
The first step is to calculate the depreciation cost per unit (hour):
You would use the rate per machine hour to determine depreciation expense each year.
For 2017, depreciation expense is as follows:
The adjusting entry for depreciation expense on December 31, 2017, is shown below.
| Date | Accounts and explanation | Debit | Credit |
|---|---|---|---|
| December 31, 2017 | Depreciation expense | $9,900 |
-
|
|
-
|
Accumulated depreciation
|
-
|
$9,900 |
|
-
|
Adjusting entry for depreciation |
-
|
-
|
The table below shows the depreciation expense, balance in the accumulated depreciation account, and book value for this asset over its useful life. The calculations for accumulated depreciation and book value are shown below the value in the table.
| Date | Depreciation per machine hour |
Number of machine hours |
Depreciation expense |
Accumulated depreciation |
Book value |
|---|---|---|---|---|---|
| Dec. 31, 2017 | $2.25 | 4,400 | $9,900.00
|
$9,900.00 | $40,100.00
|
| Dec. 31, 2018 | $2.25 | 4,000 | $9,000.00
|
$18,900.00
|
$31,100.00
|
| Dec. 31, 2019 | $2.25 | 4,600 | $10,350.00
|
$29,250.00
|
$20,750.00
|
| Dec. 31, 2020 | $2.25 | 3,600 | $8,100.00
|
$37,350.00
|
$12,650.00
|
| Dec. 31, 2021 | $2.25 | 3,400 | $7,650.00
|
$45,000.00
|
$5,000.00
|
The amount shown in the depreciation expense column is the dollar amount you will use for the adjusting entry to record depreciation expense for the year. The accumulated depreciation column shows the balance in the accumulated depreciation ledger account at the end of the year after the adjusting entry has been recorded. Book value at the end of each year equals the original cost of the asset minus the balance in accumulated depreciation at the end of the year. The dollar amount for book value will appear on the balance sheet at the end of the year.
At the end of the useful life of this asset (December 31, 2021), the balance in accumulated depreciation must equal the cost of the asset minus residual value, $45,000, and the book value of the asset must equal the residual value, $5,000.
In this method, you would calculate depreciation based on actual usage; therefore, it does not matter when the asset is purchased during the year.
The video below illustrates using the units of production of depreciation.