6. Units of Production

Let's talk about the units of production method. Like the straight line method, the units of production method is great because it's really easy. In units of production, the life does not equal years. Instead, the life equals some kind of unit, and the unit could be number of widgets produced, or it could be number of hours that the machine is running for. So you could say it has something like a 20,000-hour life, but you don't leave it on all day, every day, so it's not like you can calculate, oh, 20,000 hours is gonna be this many months or whatever.

So units of production turns out to be almost exactly like straight line, except that instead of coming up with an answer that's dollars of depreciation per year, you come up with an answer that's dollars of depreciation per unit. So let's look at that. The units of production method takes the cost minus the salvage value and puts that over the lifetime number of units. So if you have a $100,000 machine with a $10,000 salvage value, and you can produce 900,000 units. So the problem says, this machine is expected to produce 900,000 units before it doesn't work anymore.

Then you end up with $90,000 over 900,000. Remember, this is dollars and this is units. So you end up with $1 for every 10 units, or 10 cents, $0.10 for every one unit. So you see, it's just like straight line depreciation in that we take the depreciable base and put it over the life, but the difference is this life is a unit instead of a year. So you don't come up with a dollar per year, you come up with a dollar per unit. Now, this hasn't really told us what to do yet as far as taking depreciation expenses, but then you're gonna see a schedule that says something like Year 1, 200,000 units produced.

What's your depreciation expense? Well, you know it's 10 cents per one unit, so you do $0.10 times 200,000 units, and you get: the first year I should depreciate $20,000. So units of production is pretty easy in that you get a dollar per unit rate, and then you multiply that by units, and you're left with the depreciation expense.

And that's really all there is to it. And you'll notice up here that we're using depreciable base in the formula. So as long as you're not going over the 900,000 units, you're not going to depreciate too far. You're not going to depreciate beyond your salvage value because you took your salvage value into account when you were coming up with your rate of 10 cents per unit. For units of production, it's simply rate per unit times units gives you depreciation expense.