Units-of-Activity Depreciation

Brian Krogol
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Alright, let's talk about a common depreciation method here? The units of production method. So the units of production method, sometimes it's called the units of activity method? It means the same thing? So depreciation, Remember, what do we, why do we use depreciation? What's because we bought some fixed asset that we're gonna use for a long time more than a year. And what we did is we probably spent a lot of money on this asset and we want to break up that cost, we spend all this money on the asset. We want to break it up over its useful life. Okay, and that's what depreciation does. It breaks up that upfront, cost over the useful life of the asset. So whenever we calculate depreciation in all the different methods, we're always going to be concerned about three variables cost, which is what we spent on it, Right? The initial cost of the asset, then we're gonna have to estimate a useful life, and this is how long the company expects the asset to help us generate revenue. Now, in this method, it's a little different than we're used to this method. We're not talking about units of time, like how many years is this gonna help us? We're talking about the useful life is going to be in a number of units. So Depending on the asset, it could be different if it's, let's say a truck, well, it could be, how many miles are we going to get out of the truck? If it's some machine in our factory, how many units is it going to produce for us? Is it gonna produce 100,000 units in our factory, 200,000 units. What is that estimate of the amount of units? Okay, so it's a number of units, not a measurement of time. So that's the difference in this method. And lastly we have our residual value, That's our third variable here. How much the company expects the asset to be worth at the end of the useful life. So once we're done using it, how much is it gonna be worth? And remember that these two useful life and residual value, they're both estimated by the company. Okay, so residual value? Well, it has other names, like we've said, it has salvage value, scrap value. They all mean the same thing. Right? So let's go ahead here into our uh, depreciate our units of production method. And let's see our formula that we use in this method. So in this method, what we what we calculate is a depreciation per unit of output. Okay, So what we're gonna do is like if it's a truck per mile that we drive, how much depreciation is it? Or if it's a machine that's producing units, how many, how much depreciation per unit? It produces. Okay, so it's a similar formula to our straight line formula in our numerator we have cost minus residual value. And remember this is our depreciate ble base? So this is the total amount of depreciation that we're going to take over the useful life? right? We paid some costs for it, and then we subtract out what it's worth at the end and everything else in the middle. Well, that's the depreciation. But notice in the denominator, it's no longer a unit of time. It's units of output. Like those total number of miles, or the total number of units that's going to produce in the factory. Right? So it's gonna be like that. So why don't we pause here and then we'll go into an example of how we do the units of production in the next video. Alright, let's do that now?