Depreciation: Units-of-Activity - Video Tutorials & Practice Problems

Units-of-Activity Depreciation

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?

Units-of-Activity Depreciation

Alright let's try this example on january 1st year one, johnson and johnson and johnson company purchased a delivery truck for $42,000 the company estimated a useful life of 100 and 20,000 miles. So notice are useful life is in miles now, not in years And a residual value of 2000. So we think after 100 and 20,000 miles while this truck's not gonna work anymore during year one, the truck was driven 36,000 miles. Okay, so that's that tells us how much depreciation we're going to take in the first year, is how many units we've driven? So what would be the entry to record depreciation when preparing the year one financial statements and the netbook value on that date. Okay. So it has to give you this information of how many units we used up during the year. Alright. So the first thing we wanna do is calculate our depreciation per unit. So what we have is our cost of 42,000 -2000. Right? So let's do depreciation per unit and that's gonna equal are 42,000 minus our residual value of 2000. And we're gonna divide that by are useful life of 100 and 20,000 units. So 40,000 Divided by 120,000, that's gonna equal 0.33333. Right? Forever. So you want to be careful because if you rounded that off 2.33, it might not give you the same answer as if you put in a lot of threes. So I'm always paranoid and when I put it in my calculator, especially on a test. I don't want to get something wrong, I'll jam that three button. I'll fill that calculator with threes until there's no more space left, and then I'll do my multiplication. Alright, so let's go ahead and let's find our depreciation expense for year one. So in year one, in year one, our depreciation expense. Well, we know our depreciation per unit, right? This is gonna be per unit. Well, in this case it's per mile driven, right? So for each mile driven we're gonna take .3333. And let's see what that gives us. So I'm gonna pull up my calculator and I'm gonna press 0.3 until I can't press the three anymore. And then I'm gonna multiply that by 36,000 And there we go. Now I can round it. Now I feel safe rounding after the fact. So it looks like it's gonna be 12,000 in depreciation the first year. Right? So this is our depreciation expense. We found it. Now we're talking about, this is $12,000 of depreciation, right? This was 30 33 cents per unit here, but this was 36,000 miles driven, right? We drove 36,000 miles during the first year. And at that rate of 33.3 33 cents per unit. We got 12,000 in depreciation expense. So the depreciation expense. Well, that entry always looks the same. No matter what, No matter what method we're using for depreciation. It's always gonna look like this debit depreciation expense, credit accumulated Q accumulated depreciation. Okay. And that's gonna be in this case 12,000 As our debit. 12,000 as our credit, right? We debit the expense and credit accumulated depreciation. So there we go. That is going to be our entry to record depreciation. So all we need to do is find our netbook value. Now remember netbook value, that's just the cost, what we paid for it minus all the depreciation to date minus all accumulate, right? All the accumulated depreciation. So let's do that over here. Netbook value, it's gonna equal our cost of 42,000 minus our accumulated depreciation, which to this point was just 12,000. And our net book value would be 30,000 at the end of the first year. Okay, so there there it is our depreciation expense entry and our net book value. So this entry, this method is not so tough because what you do is after you found this rate, which is what you do in the first step. Well then all you need to do is find each year's number of miles. And you're just gonna keep multiplying it by the rate. And there you go. That'll give you your depreciation expense each year, and they're gonna have to give you that information. They're gonna have to tell you how many miles you drove each year. All right, so let's go at the bottom of the page, I've got another little table where we're gonna follow this truck through its entire useful life using this units of production method. Alright, let's do that in the next video.

Units-of-Activity Depreciation

Alright, so let's go ahead and follow this truck through its entire useful life using this units of production method. So I've got some of the data from above. And remember, we estimated we had an estimated useful life in this case, it's not in years, It's in miles, right? This is 100 and 20,000 miles. And we had figured out our rate per mile above which is the first step was going to be 0.33 repeating right? Three's forever per mile. So for each mile driven each year we're gonna take that much to appreciate. Now remember that the one trick here is that we have to find once we've used up the entire useful life because they use the useful life that we're depreciating over is 100 and 20,000 miles. So once we've gone through 100 20,000 miles, we don't take any more depreciation. So let's go ahead and start here in january 1st Year one. Well, that's when we bought the truck, We haven't driven it yet. Our net book value is going to be the entire value of the truck, which is the 42,000. Alright, Alright, that over here. 42,000, Cool. And then we calculated during year one, right? We already did Year one's calculation where we drove 36,000 miles times the 10.333 cents per mile. We got a depreciation expense of 12,000. Right, So this gave us accumulated depreciation of 12,000 and this brings our netbook value from 42,000 minus the 12,000 down to 30,000. Right? So let's keep on going here during year two? We drove it for 24,000 miles. So let's see what that comes out to 24,000 divided by three. Well, that's how I do it. 24,000 divided by three because really this is one third, Right? So that's another way to do it. But if you if you don't know if you can't deal with those fractions like that, you can just do times 10.33333. And you want to make sure you max out those threes and you're gonna round it here, you'll see your right at 8000. Right? So this is 24,000 times the rate of 0.33, repeating. And that will give us 8000 in depreciation expense for the second year notice. It's not going in any particular order. It just matters how many miles you drove it. Look in year three, we drove it more miles than in year two. So, it's not like it's gonna keep decreasing over time or increasing. It just matters how many miles we drove the truck. So in 8000, with 8000 in depreciation for year to our total accumulated depreciation is gonna increase To 20,000. Right? So, now we've got 42,000 minus the 20,000 accumulated, gets us to a value of 22,000 in netbook value. Cool. All right. What about in year three? So now year three, we drove it another 30,000 miles. Have we reached that estimated useful life yet? No, it doesn't look like it. It looks like we've still got some space. So we don't have to really worry about that just yet. So another 30,000 miles. So let's find out what that rate is gonna be 30,000 times 0.33 repeating. And that's gonna give us 10,000 in depreciation for year three. Right? So, if we do our previous accumulated depreciation of 20,000 plus another 10,000, well, that gets us to 30,000 in total accumulated depreciation. And it brings our net book value down to 12,012,000. So let's keep going here in year four. Well, why don't we calculate how many miles we've driven the truck just to make sure we're not gonna run out of miles here? 36,000 plus 24,000 plus 30,000. So, we've driven the truck 90,000 miles after three years. So, we have another 30,000. Right? Our total estimated useful life is 120,000 miles. And that's what we're that's what we are depreciating this truck over is the 120,000 miles. So we just want to make sure we don't go over that amount. So in year four, we've got space for that. Let's do the entire 18,000 here 18,000 times 0.33 repeating. And that gives us 18,000 divided by three really is 6000. Cool. So 6000 isn't is added to our accumulated depreciation plus 6000 Is equal to 36,000. There we go. Alright, so now let's see what our remaining net book value is. And we're left with 6000 in remaining netbook value. And we're trying to get to an estimated residual value of 2000. Right? So we are getting pretty close to to running out of miles here in our estimated useful life. So let's go ahead and remember this estimated useful life. It's just an estimate. It might last longer, it might last shorter. So we just want to make sure that we depreciate only over that estimate that we made. So 36 plus 24 plus 30 plus the 18 from year four gets us to 100 and 8000 miles. We've already driven it 108,000 miles before we get to Year five. So how many miles are left in its estimated useful life? There's only 12,000 left, right, 120,000 minus the 108 that we've driven from these four years. We had already driven 100 8000 miles. Well, there's only 12,000 miles left, but in year five we drove it 16,000. So are we gonna multiply 16,000 times 0.33. No, no, no. We can only depreciate it with the amount of miles left in its estimated useful life. If we use the whole 16,000, what we would go under the residual value and we don't want to do that. So all we're gonna do is we're gonna depreciate it for the 12,000 miles left in its useful life Times 2.333. And that's gonna give us 4000 in depreciation. And that gets us to 36,000. Look at, look what happens in our accumulated depreciation, It equals 40,000. Remember that our depreciation base, that's the 42,000 minus the 2000. So the total amount of depreciation we can take is 40,000. Okay, and that's exactly what's happened here when we reduced it in year five. So actually I'm gonna write this 12,000 in a different color. So that it stands out a little bit because we used a little bit of math to get to that 12,000. Okay, so we want to make sure that our total depreciation is equal to our depreciation base of 40,000. And then what's gonna be left in our net book value? Well, just our residual value. Right, so 42,000-40,000 gets us to 2000. Now, what about in year six when we continue to drive the truck for another 8000 miles? Well, we've already fully depreciated. We're not gonna take any more depreciation expense are accumulated depreciation, still 40,000 on our books and our net book value is still going to be the 2000 in residual value there. Cool. Alright. So now that you guys have seen the units of production method, why don't you guys try some practice problems? Alright, let's do that now.

ABC Company purchased a new machine on January 1, Year 1 for $44,000. The company expects the machine to produce 50,000 units. The company thinks it could sell the scrap metal from the machine for $4,000 at the end of its useful life. If the company uses the units-of-production method for depreciation, what will be the net book value of the machine on December 31, Year 1, if 15,000 units are produced with the machine during the year?

• A. $12,000
• B. $13,200
• C. $30,800
• D. $32,000

DBQ Company purchased a machine on January 1, Year 1 for $60,000. The company estimated a 300,000 unit production useful life and $8,000 residual value. During Year 1, the company produced 90,000 units. During Year 2, the company produced 30,000 units. If the company uses the units-of-production method for depreciation, what will be the amount of accumulated depreciation on December 31, Year 2?

• A. $5,200
• B. $6,000
• C. $20,800
• D. $24,000

XYZ Company purchased a machine on January 1, 2018 for $110,000. The company estimated a 20,000 unit useful life and $10,000 residual value. XYZ produced 8,000 units in 2018; 6,000 units in 2019; and 10,000 units in 2020. If the company uses the units-of-production method for depreciation, what will be the amount of depreciation expense for the year 2020?

• A. $30,000
• B. $40,000
• C. $50,000
• D. None of the above