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Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

8. Long Lived Assets

# Depreciation: Units-of-Activity

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#### concept

Units-of-Activity Depreciation 3m
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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?
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#### example

Units-of-Activity Depreciation 4m
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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.
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#### example

Units-of-Activity Depreciation 7m
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Problem

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?

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Problem

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?

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Problem

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? 