How to Calculate Activity-Based Depreciation
Calculate activity-based depreciation effectively. Understand how an asset's actual usage determines its value reduction for precise financial tracking.
Activity-based depreciation allocates an asset’s cost over its useful life based on its actual usage or output, rather than the passage of time. This method provides a more accurate reflection of an asset’s consumption, especially for machinery, vehicles, or equipment where wear and tear directly correlate with use.
Understanding the Core Elements of Activity-Based Depreciation
Before calculating activity-based depreciation, identify several fundamental components. The asset cost includes the purchase price and all expenditures to prepare it for its intended use, such as shipping, installation, and testing.
The salvage value is the estimated amount a company expects to receive from selling or disposing of the asset at the end of its useful life. This estimate is subtracted from the asset cost to determine the total amount that will be depreciated. The depreciable base is the asset’s cost minus its salvage value, representing the total value expensed over its operational life.
The estimated total activity defines the asset’s total expected output or usage over its entire useful life. This can be measured in units of production or service hours. The actual activity for the period is the precise measurement of the asset’s output or usage during a specific accounting period.
Calculating Depreciation with Units of Production
The units of production method calculates depreciation based on the asset’s output. This makes it suitable for assets whose wear and tear are directly linked to the volume of items they produce. This method aligns depreciation expense with the asset’s actual contribution to production.
The depreciation rate per unit is determined by dividing the depreciable base by the estimated total units of production. For example, if a machine costs $100,000, has a salvage value of $10,000, and is expected to produce 180,000 units, its depreciable base is $90,000. The rate would be $90,000 divided by 180,000 units, resulting in $0.50 per unit.
The depreciation expense for the period is calculated by multiplying the depreciation rate per unit by the actual units produced during that accounting period. For instance, if the machine produces 30,000 units in the first year, the expense would be $0.50 per unit multiplied by 30,000 units, equaling $15,000. If in the second year it produces 40,000 units, the expense would be $20,000.
Calculating Depreciation with Service Hours
The service hours method is effective for assets where depreciation is driven by operational time rather than units produced. This method applies to equipment like vehicles or machinery used for varying durations. It precisely matches the asset’s expense to its actual usage.
The depreciation rate per hour is calculated by dividing the asset’s depreciable base by its estimated total service hours. For example, equipment purchased for $60,000 with a salvage value of $5,000 and an expected life of 11,000 hours has a depreciable base of $55,000. Dividing $55,000 by 11,000 hours yields a rate of $5.00 per hour.
The depreciation expense for the period is determined by multiplying the depreciation rate per hour by the actual service hours operated. If the equipment runs for 2,500 hours in the first year, the expense would be $5.00 per hour multiplied by 2,500 hours, resulting in $12,500. If in the second year it operates for 3,000 hours, the expense would be $15,000.
Ongoing Application of Activity-Based Depreciation
Maintaining activity-based depreciation accuracy requires diligent tracking of actual activity. Businesses must implement reliable systems to record precise usage or output. This data collection is crucial for correctly applying the per-unit or per-hour depreciation rate.
Once calculated, the depreciation expense must be properly recorded in accounting records. This involves debiting the Depreciation Expense account and crediting the Accumulated Depreciation account. This reduces the asset’s book value on the balance sheet, reflecting its consumed economic value.
The process continues until total accumulated depreciation equals the depreciable base. At this point, the asset has reached full depreciation, and its book value is reduced to its salvage value. No further depreciation expense is recognized, and the asset continues to be reported at its salvage value until disposal.