Unit of Production Method

What Is the Unit of Production Method?

The unit of production method is a method of working out the depreciation of the value of an asset over the long run. It becomes helpful when an asset's value is all the more closely connected with the number of units it creates as opposed to the number of years it is being used. This method frequently results in greater deductions being taken for depreciation whenever the asset is vigorously utilized, which can then offset periods when the equipment experiences less use.

This method can be diverged from time-based measures of depreciation, for example, straight-line or accelerated methods.

The Formula for the Unit of Production Method Is

Depreciation expense for a given year is calculated by partitioning the original cost of the equipment less its salvage value, by the expected number of units the asset ought to deliver given its helpful life. Then, increase that quotient by the number of units (U) utilized during the current year.
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What Does the Unit of Production Method Tell You?

Basically, the units of production depreciation expense claimed in a year is based upon which percentage of an asset's production capacity was spent during that year. This depreciation method can assist companies with taking bigger depreciation deductions whenever a given piece of equipment is more useful. Companies claim depreciation on a piece of equipment or property for bookkeeping, yet in addition for tax deductions. Bigger deductions in additional useful years can assist with offsetting other, higher costs associated with higher production levels.

The unit of production method most precisely measures depreciation for assets where the "wear and tear" is based on the amount they have delivered, like manufacturing or processing equipment. Involving the unit of production method for this type of equipment can assist a business with keeping track of its profits and losses more precisely than a sequence based method like straight-line depreciation or MACRS methods.

The unit of production method depreciation starts when an asset starts to create units. It closes when the cost of the unit is completely recuperated or the unit has delivered all units inside its estimated production capacity, whichever starts things out.

Unit of Production versus MACRS Methods

The modified accelerated cost recovery system (MACRS) is a standard method for devaluing assets for tax purposes. Rather than being dependent on the number of units an asset could create, this depreciation method includes estimations that outcome in the asset's value being depreciated with a declining balance for a set period of time, then switching to a straight-line depreciation method to complete the depreciation schedule.

For tax purposes, the IRS expects businesses to devalue property utilizing the Modified Accelerated Cost Recovery System (MACRS), however it permits businesses to prohibit property from this method in the event that it very well may be precisely depreciated by another method like the unit of production method. To utilize this method, the owner must choose exclusion from MACRS by the return due date for the tax year the property is initially positioned into service.

For more data in regards to this election and the particulars of how to make the election, see IRS Publication 946, How to Depreciate Property.

Highlights

• The unit of production method for computing depreciation considers an asset's viable use in the production cycle as opposed to thinking about its time being used.
• This method can permit companies to show higher depreciation expense in additional useful years, which can offset other increased production costs.
• This method is especially used for assets that experience a high degree of wear and tear based on real use per-unit like certain bits of machinery or production equipment.