Depreciation is a parameter that basically counts how much of your asset’s (be that equipment, capital, or something else) value was lost over some period of time.
The Units method is best utilized with assets whose depreciation rate depends on how much they produce in terms of units. Production equipment is the most common type of asset being depreciated, although it’s not just restricted to that.
Accounting for depreciation
Everything loses value over time, and any business will want to know roughly how much value or efficiency of their property was lost during some time. You can count it monthly, although with big machines and other equipment it’s much more reasonable to conduct yearly evaluations.
Despite that, you can almost always count the rate of depreciation with any asset. These methods aren’t generally used to determine the value loss, but rather how fast it diminishes. This helps with several important management aspects, including:
- Evaluation of the asset’s remaining time of service considering different rates of wear (current, reduced, increased)
- Assessment of factors that accelerate the wear and potential remedies that may slow the rate down
- Cost-effectiveness of keeping the asset in operation.
Generally, assessing depreciation helps you understand just how fast the asset (equipment, in this case) is wearing down. With this information, you can do whatever you want, but you’ll mainly want to improve the efficiency of your production.
That’s why it’s so important to estimate depreciation, and the Units method helps you do it for machinery and other property that wears down mainly from producing and usage per unit of a product rather than time in service (which is just gradual linear depreciation).
Method of Production Units
As you might’ve guessed, the Units of Production method stands in contrast to other methods that mainly estimate depreciation over time. Since machinery and other similar assets are more prone to wearing down from each individual production cycle rather than from constant unchanging work, this method works best for it.
That being said, no one stops you from estimating depreciation using different methods. It’s just important to remember that the Units of Production method estimates depreciation per unit.
So, if you want to estimate the depreciation of a sewing machine, you can estimate the wear suffered per each piece of clothing made with it. You’ll get a coefficient of how much the machine depreciates from creating one piece of clothing. Then, feel free to multiply it by the number of clothing pieces made in a month/year/week to determine the rate.
There is a formula used to calculate the depreciation sustained per unit of production for each independent asset:
D = ((Initial Asset Value – Current Asset Value)/Total Units Produced) * U/p
- D – Depreciation rate
- U/p – Units produced per accounted period (month/year)
Simply put, you divide the value lost since the beginning (represented in a way you want) by the number of units produced in that same period. What you get is a coefficient for how much the asset is depreciating per unit.