DEPRECIATION:

PRODUCTION COST METHOD

Francois Vermaak
 Terminology
• Cost basis of the asset is the historical cost of the
asset (including shipping, delivery and installation
fees)
• Salvage value is the estimated value at the end of
its useful life (what you estimate to sell it for at
the end of useful life)
• Units of production rate is the Cost basis of the
asset LESS Salvage value DIVIDED by the
estimated total number of units to be produced
over estimated useful life
 Basic Formula

(Cost Basis of Asset – Salvage Value) Actual units

Estimated total units produced produced
over lifetime of asset

Units of production rate

 Example
• Umpalumpa Chocolate Manufacturers purchased a
fold-wrapping machine on 1 March 2021 for R250 000.
Transport cost to deliver the machine to the factory
was R15 000 and cost to install the machine was R35
000.
• The machine wrapped 100 000 chocolate slabs for the
year ended 28 February 2022.
• Umpalumpa Chocolate Manufacturers estimates the
machine to wrap 500 000 chocolates until it is
decommissioned on 28 February 2026. It hopes to sell
the machine for R40 000 when it is decommissioned.
 Example TOTAL
• Umpalumpa Chocolate Manufacturers purchased COST
a fold-wrapping machine on 1 March 2022 for R300 000
R250 000. Transport cost to deliver the machine
to the factory was R15 000 and cost to install the ACTUAL
machine was R35 000. FOR YEAR
• The machine wrapped 100 000 chocolate slabs 100 000
for the year ended 28 February 2022.
• Umpalumpa Chocolate Manufacturers estimates EST
the machine to wrap 500 000 chocolates until it is TOTAL
decommissioned on 28 February 2027. It hopes to LIFESPAN
sell the machine for R40 000 when it is
decommissioned. 500 000
SALVAGE
COST
R40 000
 Example TOTAL
COST
R300 000
Cost basis of asset – Salvage value Actual units
= X
Estimated total units over lifetime produced ACTUAL
FOR YEAR
[(250 000 + 15 000 + 35 000) – 40 000] 100 000
= X 100 000
500 000
EST
= R52 000 depreciation for 2022 financial year TOTAL
LIFESPAN
500 000
SALVAGE
COST
R40 000
 Example (continued)
• The actual units produced in subsequent years
is used to calculate the depreciation annually.
Accumulat
Units of
Actual Depreciatio ed Carrying
Year production
production n Depreciatio value
rate#
n
2023 0,52 100 000 R52 000 R 52 000 R248 000
2024 0,52 100 000 R52 000 R104 000 R196 000
2025 0,52 80 000 R41 600 R145 600 R154 400
2026 0,52 120 000 R62 400 R208 000 R 92 000
2027 0,52 100 000 R52 000 R260 000 R 40 000
# Remains the same as year 1: [(250 000 + 15 000 + 35 000) – 40 000] / 500 000
 With permission: S. Rademeyer

Practise 1
A material factory bought a weaving machine for
R90 000. It should be able to weave 225 000 m2 of
material during its useful life. At the end of this period
it is going to have no value. They will need to dump it.
This year it weaved 9 000m2.
a) How much depreciation will it be per unit?
b) How much total depreciation will be recorded at year
end?
c) How many years will this machine last?
Practise 1
a) R90 000 ÷ 225 000m2 = 40 cents per metre
b) 0,40 cents p/m2 x 9 000 m2 = R3 600
c) 225 000m2 / 9 000m2 = 25 years
or R90 000 / R3 600 = 25 years
 With permission: S. Rademeyer

Practise 2
A chocolate factory bought a machine that makes chocolate
eggs. The machine cost R240 000 and is expected to have a
salvage value of R48 000 at the end of its useful life. It is
supposed to be able to produce 2 000 000 chocolate eggs.
This year it produced 250 000 eggs.
a) Calculate the depreciation for 1 chocolate egg.
b) Calculate the total amount of depreciation for the year.
c) How many years is the chocolate egg machine expected
to last?
Practise 2
a) R240 000 – R48 000 = R192 000
R192 000 ÷ 1 980 000 = 0,096 cents p/egg
b) 0,096 cents x 250 000 eggs = R24 000
c) 192 000 / 24 000 = 8 years
or 2 000 000 / 250 000 = 8 years
 With permission: S. Rademeyer
Practise 3
A paper factory bought a machine on 31 August that turns
wood pulp into paper. The machine cost R1 500 000 and is
expected to produce 24 500 tons of paper in total. This year it
produced 1 750 tons. The year-end is on 28 February. Its
salvage value at the end of its useful life is expected to be
R348 500.
a) Calculate the depreciation per ton of paper.
b) Calculate the depreciation at year-end at the end of the 1st year.
c) Calculate the depreciation at the end of the 2nd year.
d) How many years is the paper machine expected to last?
Practise 3
a) (1 500 000 – 348 500)
1 151 500 / 24 500 = R47
b) R47 x 1 750 = 82 250
c) 82 250 x 2 = 164 500
d) 1 151 500 / 164 500 = 7 years,
OR 24 500 / 3 500 = 7 years.
Thank you!