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Simple English definitions for legal terms
units-of-production method
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A quick definition of units-of-production method:
The units-of-production method is a way of calculating how much a piece of property has depreciated over time. It works by estimating how many units of a product the property will produce during its lifetime and then dividing the total cost of the property by that number. This method is often used in the oil-and-gas industry when the number of units of production can be accurately estimated, such as the number of barrels in a reserve.
A more thorough explanation:
The units-of-production method is an accounting method used to calculate depreciation. It involves estimating the total number of units that a property will produce during its useful life and then calculating the depreciation expense based on a fixed rate per unit.
For example, let's say a company purchases a machine for $100,000 that is expected to produce 100,000 units over its useful life. The company estimates that the salvage value of the machine will be $10,000. Using the units-of-production method, the company would calculate the depreciation expense as follows:
Depreciation per unit = (Cost - Salvage value) / Total units of production
Depreciation per unit = ($100,000 - $10,000) / 100,000 = $0.90 per unit
If the machine produces 10,000 units in the first year, the depreciation expense for that year would be:
Depreciation expense = Depreciation per unit x Units produced in the year
Depreciation expense = $0.90 x 10,000 = $9,000
The units-of-production method is commonly used in industries where the total number of units of production can be accurately estimated, such as the oil and gas industry.