Home » Accounting Explanation » Depreciation- Its Nature, Calculation and methods


Units of output method

Units of output method is used on specific types of fixed assets or companies consider at times that units of output method is more appropriate for calculating depreciation expenses of the fixed assets

The method is fairly simple. In this method of depreciation, depreciation expense for an accounting period is calculated on the basis of number of units/products a machine (or a fixed asset) produces in an accounting period

Formula



Example

The cost of a machine purchased by ABC Company was $6000. It was estimated that the machine will have a $1000 residual value and it will last for 5 years. The machine total expected production was estimated at 500 units during its useful life time. However, during the first year of operation, it produced 100 units of output. Calculate the depreciation expense for the first year


Cost of the machine = $5000
Residual value = $100
Useful life = 5 years
Total expected units = 500 units
Current years or accounting period units=100 units


Formula



By putting values in the formula

Depreciation = ($6000-$1000)/500 units X 100 units

Depreciation = 5000/500 X 100

Depreciation = 10 X 100

Depreciation = $1000

Hence, $1000 is the depreciation expense of the machine for the first year

Now, let’s assume in the 2nd year, the machine produced 150 units. We are now required to calculate the depreciation expense for the 2nd year

Following are the values that we need to calculate depreciation expense. You might have noticed that all values are same except the one which is the current year or accounting units

Cost of the machine = $5000
Residual value = $100
Useful life = 5 years
Total expected units = 500 units
Current years or accounting period units=150 units

Formula



By putting values in the formula


Depreciation = ($6000-$1000)/500 units X 150 units

Depreciation = 5000/500 X 150

Depreciation = 10 X 150

Depreciation = $1500

Hence, $1500 is the depreciation expense of the machine for the 2nd year


Land and Depreciation

By now, you should be well aware of depreciation and its calculating. As we mentioned in the begging of this topic that depreciation is the part of fixed asset’s cost that is decreased/consumed/expired during an accounting period. Now assume that a fixed asset has an unlimited or endless life. Since that fixed asset has an unlimited life, its cost/value does not expire/consume rather its cost remain same even after 10 or 20 years. Moreover, in some cases we can sell that fixed asset at any time in future and most probable it will be sold for a price higher than the price we had paid at the time of buying it. So, what does this mean? It implies that the fixed asset value is still the same as it was before (or in some cases its values could be higher). If a fixed asset value remains same or even increase because it has an unlimited useful life, then how can we charge depreciation on it? Land is that type of fixed asset, it has an unlimited useful life and hence its value doesn’t decrease. Therefore, it is inappropriate to charge depreciation expense on land (freehold land)

On the other hand, if the useful life of land is limited or determinable, then land needs to be depreciated. In theses circumstances, a portion of land’s cost should be recognized as depreciation expense each year or accounting period since the land will be put out of use and its cost will expire or use up to its residual value

To sum up, if the useful life of land is limited or determinable, Depreciation expense of land should be calculated. As opposed to this, if the useful life of land is infinite/unlimited/indeterminable, depreciation should not be provided for land

Generally land is not depreciable. However, land can be depreciated under the following conditions

- Land at the sea-shore will be occupied by sea because of increasing water level in the sea
- Land will be taken by government (nationalization) in future
- Land will be destroyed because of river changing its direction
- There is a legal restriction on its future use
- Land sliding when land is located at a mountains area