The units of production method is a depreciation method that allocates an asset's depreciable cost according to its actual usage during each period. Instead of assuming the asset wears out evenly over time, it assumes the asset's service potential is used up by output or activity, such as the number of items produced, hours of operation, miles driven or tons of material extracted. The more the asset is used in a period, the higher that period's depreciation expense.
The method is used for assets whose wear depends mainly on use, such as manufacturing machinery, delivery trucks, aircraft engines and mining equipment. A closely related approach, depletion, applies the same logic to natural resources such as oil reserves, timber and mineral deposits, as described under depletion expense. Both are accepted under US GAAP and IFRS when they reflect the pattern in which the asset's benefits are consumed.
Formula
First, a depreciation rate per unit is calculated:
Then each period's charge is:
- is the asset's purchase price plus costs to make it ready for use.
- is the estimated amount recoverable at the end of its life.
- is the expected lifetime output or usage, in units, hours or miles.
- is the actual output or usage during the period.
Worked example
A packaging company buys a machine for $260,000. It expects the machine to produce 2,000,000 boxes over its life and to have a salvage value of $20,000. The depreciation rate is $260,000 minus $20,000, divided by 2,000,000, or $0.12 per box.
| Year | Boxes produced | Depreciation expense | Accumulated depreciation | Book value |
|---|---|---|---|---|
| 1 | 300,000 | $36,000 | $36,000 | $224,000 |
| 2 | 550,000 | $66,000 | $102,000 | $158,000 |
| 3 | 480,000 | $57,600 | $159,600 | $100,400 |
| 4 | 420,000 | $50,400 | $210,000 | $50,000 |
| 5 | 250,000 | $30,000 | $240,000 | $20,000 |
Each year the company debits depreciation expense and credits accumulated depreciation. After 2,000,000 boxes, book value equals salvage value, and depreciation stops even if the machine keeps running. In a year when the machine is idle, depreciation under this method is zero.
Advantages and disadvantages
The method matches cost closely with the revenue the asset helps produce, in line with the matching principle. In busy years, when more products are sold, depreciation is higher; in slow years, lower. This makes product costs more accurate, because depreciation becomes a variable cost per unit rather than a fixed charge, which is useful in pricing and in cost-volume-profit analysis.
Its drawbacks are practical, and idle assets may still need an impairment review. Total lifetime output must be estimated, which can be difficult, and usage must be measured and recorded every period. The method ignores the effect of time: assets also deteriorate, rust or become obsolete when idle, so a machine used lightly may lose value faster than the method suggests. It is therefore unsuitable for assets such as buildings and office equipment, where the straight-line method is more appropriate.
Comparison with other methods
Straight-line depreciation charges equal amounts each year, while the declining-balance method front-loads depreciation. Units of production varies with activity, so it can resemble either pattern depending on how usage changes. All methods charge the same total, cost minus salvage value, over the asset's life. If the estimate of total units changes, the remaining depreciable amount is spread over the revised remaining units as a change in accounting estimate. For US federal income tax, the units of production method may be elected for certain property instead of MACRS, but most businesses use MACRS for tax and a different method for their books.