Concept And Accounting of Depreciation

Units of Production Method

Depreciation is a decrease in the value of assets due to normal wear and tear, the effect of time, obsolescence due to technological advancements, etc. However, depreciation includes amortization. Units of Production Method is a method of charging depreciation on assets. Let us learn about it some more.

Units of Production Method

This method of charging depreciation on the asset is based on the units produced during the year. The estimated total production of the asset is the criteria for providing depreciation.

This method is applied where the value of the asset is more closely related to the number of units it produces. Thus, in the years when the asset is heavily used, the amount of depreciation will be high.

Assets on which this method can be applied are Plant and Machinery. As their wear and tear will depend on how much we use them.

For example, a machine has a capacity to produce 1000000 meters of cloth over its useful life. Then it is advisable here to follow the units of production method.

The amount of depreciation for a year is calculated by dividing the total depreciable amount of the asset by estimated total production into units. We then multiply this figure with the number of units produced during the year.

Browse more Topics Under Concept And Accounting Of Depreciation

Formula:

$$\text{Annual Depreciation} = \text{Depreciable Value} \times \frac{\text{Units produced during the year}}{\text{Estimated total production}}$$

Depreciable Value = Original cost – Scrap value

Units of Production Method

(Source: backoffice)

Solved Example on Units of Production Method

Q. M/s Cube textiles purchased machinery for ₹200000 on 1st January. It has an estimated useful life of 10 years and an estimated residual value of ₹20000.  The firm sells the asset at the residual value at the end of the 10th year. The machine has an expected production of 15000 units during its useful life. Now the production pattern is as follows:

Year Production
1-3 2000 units per year
4-7 1500 units per year
8-10 1000 units per year

Calculate the amount of depreciation using the Units of Production Method. Pass necessary journal entries. Also, prepare Machinery A/c.

Ans: Calculation of depreciation under Units of Production Method:

Depreciable Value = Original cost – Scrap value = 200000-20000 = 180000

$$\text{Annual Depreciation} = \text{Depreciable Value} \times \frac{\text{Units produced during the year}}{\text{Estimated total production}}$$

Year Annual Depreciation
1-3 180000 x 2000/15000 = 24000
4-7 180000 x 1500/15000 = 18000
8-10 180000 x 1500/ 15000 = 12000

Journal entry in the books of M/s. Cube textiles

Date                                            Particulars Amount (Dr.) Amount (Cr.)
1st year
1 Jan Machinery A/c Dr. 200000
To Cash A/c 200000
(Being machinery purchased)
1st – 3rd year
31 Dec Depreciation on Machinery A/c Dr. 72000
(24000 x 3)
To Machinery A/c 72000
(Being depreciation charged on machinery)
31 Dec Profit & Loss A/c Dr. 72000
To Depreciation on Machinery A/c 72000
(Being depreciation on machinery transferred to profit and loss account)
4th – 7th year
31 Dec Depreciation on Machinery A/c Dr. 72000
(18000 x 4)
To Machinery A/c 72000
(Being depreciation charged on machinery)
31 Dec Profit & Loss A/c Dr. 72000
To Depreciation on Machinery A/c 72000
(Being depreciation on machinery transferred to profit and loss account)
8th –10th year
31 Dec Depreciation on Machinery A/c Dr. 48000
(12000 x 3)
To Machinery A/c 48000
(Being depreciation charged on machinery)
31 Dec Profit & Loss A/c Dr. 48000
To Depreciation on Machinery A/c 48000
(Being depreciation on machinery transferred to profit and loss account)
10th year
31 Dec Cash A/c Dr. 20000
To Machinery A/c 20000
(Being machinery sold)
31 Dec Machinery A/c Dr. 12000
To Profit & Loss A/c 12000
(Being profit on the sale of machinery transferred to profit and loss account)

 Machinery A/c

Date Particulars Amount   Date Particulars Amount
Year Year
1 – 3 1 – 3
1 Jan To Cash A/c 200000 31 Dec By Depreciation A/c 72000
31 Dec By balance c/d 128000
200000 200000
4 – 7 4 – 7
1 Jan To balance b/d 128000 31 Dec By Depreciation A/c 72000
31 Dec By balance c/d 56000
128000 128000
8 – 10 8 – 10
1 Jan To balance b/d 56000 31 Dec By Depreciation A/c 48000
10th year 10th year
31 Dec To Profit & Loss A/c 12000 31 Dec By Cash A/c 20000
(profit on sale) (sale proceeds)
68000 68000
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