The Machine Hour Method is a depreciation technique based on an asset’s actual usage rather than time. Instead of allocating depreciation evenly over its useful life, this method calculates depreciation based on the number of hours a machine is used. This approach ensures that higher depreciation is recorded in periods of heavy usage, making it ideal for businesses that rely on machinery for production.
1. Understanding the Machine Hour Method
Definition
The Machine Hour Method depreciates an asset based on its actual operating hours. Businesses estimate the total working hours over the asset’s useful life and allocate depreciation proportionally to the hours used each period.
Key Features:
- Depreciation is based on machine usage, not the passage of time.
- Higher depreciation in years of greater machine usage.
- Best suited for production-based industries where machine hours can be tracked.
- Ensures depreciation reflects wear and tear from actual use.
2. Formula for the Machine Hour Method
The formula for annual depreciation using the Machine Hour Method is:
Depreciation per Machine Hour = (Cost of Asset – Residual Value) ÷ Total Estimated Machine Hours
Annual Depreciation = Depreciation per Machine Hour × Machine Hours Used
- Cost of Asset: The purchase price of the machine.
- Residual Value: The estimated value of the machine at the end of its life.
- Total Estimated Machine Hours: The expected total operating hours over its lifetime.
- Machine Hours Used: The actual hours the machine was used during the period.
3. Example of the Machine Hour Method
Scenario:
A company purchases a machine for $50,000. The estimated residual value at the end of its life is $5,000. The total expected working hours over its lifetime are 25,000 hours. The machine operates for 4,000 hours in the first year.
Step-by-Step Calculation:
Step 1: Calculate Depreciation Per Hour
Depreciation per Machine Hour = (50,000 – 5,000) ÷ 25,000
= $45,000 ÷ 25,000
= $1.80 per hour
Step 2: Calculate First-Year Depreciation
Annual Depreciation = $1.80 × 4,000
= $7,200
4. Depreciation Schedule Using the Machine Hour Method
The depreciation expense will vary each year based on the machine’s actual usage.
| Year | Machine Hours Used | Depreciation Per Hour ($) | Depreciation Expense ($) | Accumulated Depreciation ($) | Book Value ($) |
|---|---|---|---|---|---|
| 1 | 4,000 | 1.80 | 7,200 | 7,200 | 42,800 |
| 2 | 5,000 | 1.80 | 9,000 | 16,200 | 33,800 |
| 3 | 3,500 | 1.80 | 6,300 | 22,500 | 27,500 |
| 4 | 6,000 | 1.80 | 10,800 | 33,300 | 16,700 |
| 5 | 6,500 | 1.80 | 11,700 | 45,000 | 5,000 (Residual Value) |
5. Journal Entry for Machine Hour Depreciation
Each year, depreciation is recorded as follows:
Journal Entry:
Debit: Depreciation Expense
Credit: Accumulated Depreciation
Example (Year 1):
Debit: Depreciation Expense $7,200
Credit: Accumulated Depreciation $7,200
6. Advantages of the Machine Hour Method
- More Accurate Expense Allocation: Depreciation reflects actual usage.
- Better for Production-Based Assets: Ideal for machines with variable workloads.
- Fair Cost Distribution: Years with higher usage show higher depreciation expenses.
7. Disadvantages of the Machine Hour Method
- Requires Detailed Record-Keeping: Businesses must track machine hours accurately.
- Not Suitable for All Assets: Only useful for machinery and equipment.
- Variable Depreciation Expense: Difficult to predict future costs.
8. Comparison with Other Depreciation Methods
| Depreciation Method | Basis of Calculation | Best Used For |
|---|---|---|
| Machine Hour Method | Depreciation based on actual hours used. | Machinery and production equipment. |
| Straight-Line Method | Equal depreciation each year. | Office buildings, furniture, equipment. |
| Reducing Balance Method | Higher depreciation in early years. | Computers, vehicles, technology. |
When to Use the Machine Hour Method
The Machine Hour Method is ideal for businesses that use heavy machinery with variable workloads. It ensures that depreciation expenses are aligned with asset usage, making it a more realistic approach to cost allocation. However, businesses must maintain accurate records of machine hours to apply this method effectively.