A company uses depreciation for financial reporting to spread the cost of a long-term asset over the asset's life in proportion to the amount of economic benefit the company receives from using the asset. Depreciation is an expense that reduces profit. Using unit-of-production depreciation, you allocate an asset's cost based on the number of units the asset produces. You calculate a depreciation expense per unit and depreciate the asset by the number of units it produces each year. The asset is fully depreciated at the end of its useful life when it has produced all of its expected units.
1. Determine the number of units you expect an asset to produce over its useful life, such as the number of pages you expect a printer to print. For example, assume that an asset will produce 1 million units over its useful life.
2. Determine the asset's total cost, which includes the costs incurred to prepare the asset for use, and the value for which you expect you could sell the asset at the end of its useful life, which is the salvage value. In this example, assume the asset's total cost is $100,000 and assume the asset has a salvage value of $20,000.
3. Subtract the asset's salvage value from its total cost to calculate its depreciable cost. In this example, subtract $20,000 from $100,000 to get an $80,000 depreciable cost.
4. Divide the asset's depreciable cost by the number of units you expect it to produce to calculate its per-unit depreciation expense. In this example, divide $80,000 by 1 million to get a per-unit depreciation expense of 8 cents.
5. Multiply the number of units the asset produces each year by the per-unit depreciation expense to calculate the depreciation expense for that year. Do this each year until the asset has produced all of its expected units. In this example, if the asset produces 200,000 units in its first year of use, multiply 8 cents, or $0.08, by 200,000 to get $16,000 in depreciation expense for the first year.
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