22 units of production method the production method

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2.2Units of Production MethodThe production method of depreciation is based on the assumption that depreciation is mainly the result ofuse and that the passage of time plays no role in the depreciation process. If we assume that the officeequipment from the previous illustration has an estimated useful life of 10,000 hours, the depreciationcost per hour would be determined as follows:
Principles of Accounting II33Hourly depreciation Rate=lifeusefulofunitsEstimatedvalueSalvageCost0.50Br.hrs.operating0,00010006000.00Br.If we assume that the use of the equipment was 2800 hours for the first year, 3600 hours for the second,2400 hours for the third, and 1200 hours for the fourth, the depreciation schedule for the office equipmentwould appear as follows:Depreciation Schedule – Production MethodYearCostHoursDepreciationPer HourYearly Depr.Accum.Depr.Carryingvalue (Bookvalue)Beginning of theFirst yearBr. 6,000-Br. 0.50--Br. 6,000.00End of first year6,0002,8000.50Br. 1,400.00Br.1,400.004,600.00End of second year6,0003,6000.501,800.003,200.002,800.00End of third year6,0002,4000.501,200.004,400.001,600.00End of fourth year6,0001,2000.50600.005,000.001,000.00Under the production method, there is a direct relation between the amounts of depreciation each year andthe units of output or use. Also, the accumulated depreciation increases each year indirect relation to unitsof output or use. Finally, the carrying amount decreases each year in direct relation to units of output oruse until it reaches the estimated residual value.Dear learner, what can you notice from the production method?(You can use the space left below to write your response.)Under the production method, the units of output is used to measure estimated useful life for some assets.For example, for one machine number of units produced may be an appropriate measure, for anothernumber of hours may be a better measure. The production method should be used only when the output ofan asset over its useful life can be estimated with reasonable accuracy.2.3Declining Balance MethodThis method of depreciation results in relatively large amount of depreciation in the early years of anasset life and smaller amounts in later years. This method is based on the assumption of the passage oftime. Since most kinds of plant assets are most efficient when new, and so they provide more and betterservice in the early years of useful life. It is consistent with the matching rule to allocate moredepreciation to the early years than to later years if the benefits or services received in the early years aregreater.The declining-balance method is the most common accelerated method of depreciation. Under thismethod depreciation is computed by applying a fixed rate to the book value of the asset, resulting in
Principles of Accounting II33higher depreciation charges during the early years of the asset’s life. Though any fixed rate might be usedunder the method, the most common rate is a percentage equal to twice the straight-line percentage. Whentwice the straight-line rate is used, the method is usually called thedouble-declining balance method.Referring to the previous example, the equipment had an estimated useful life of four years.Consequently, under the straight-line method, the depreciation rate for each year was 25 percent, (¼years).Therefore, under the double-declining balance method, the fixed rate is 50 percent (2X 25 percent). Thisfixed rate of 50 percent is applied to the remainingcarrying book valueat the end of each year.Estimated residual value is not taken into account in computing depreciation except in the last year of anasset’s useful life, when depreciation is limited to the amount necessary to bring the carrying value downto the estimated residual value. The depreciation schedule for this method is as follows:Depreciation Schedule, Double-Declining Balance MethodYearCostFixed Depr.RateYearlyDepreciationAccumulatedDepreciationCarrying Value(BV)Date of purchaseBr. 600050%----Br. 6000End of first year600050%Br. 3000Br. 30003000End of Second year600050%150045001500End of third year600050%7505250750End of fourth year600050%250550500NB. The fixed rate of 50% is always applied to the Book value at the end of the previous year. The depreciation isgreatest in the first year and declines each year after that. Finally, the depreciation in the last year is limited tothe amount necessary to reduce book value to residual value, Br. 250 =Br.750– Br. 500 (i.e. Previous bookvalue minus residual value)Activity 10What is the major justification of using the production method of depreciation?
Principles of Accounting II

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