What it means
Most depreciation methods assume assets wear out simply because time passes. The units of production method takes a different approach.
It links asset wear and tear directly to physical usage. If a machine runs twenty four hours a day, it depreciates quickly.
If it sits idle, it does not depreciate at all. This makes your financial statements much more accurate.
For non-finance managers, this matters because it aligns your operational output with your accounting costs. Under standard time based methods, a slow month still bears a heavy depreciation burden, which hurts your profit margins unfairly.
The units of production method absorbs costs only when revenue is actively being generated by that asset. To use this method, you first estimate the total output an asset will produce over its entire lifespan.
You then calculate a depreciation rate per single unit. Each reporting period, you multiply that rate by the actual units produced.
This creates a variable cost structure for what is traditionally a fixed asset. This approach works best for heavy machinery, delivery vehicles, or manufacturing equipment where usage varies wildly from month to month.
It requires accurate tracking of output metrics, so operations and finance teams must work closely together to ensure reliable data collection.
In practice
Real-world examples.
Example
A bakery buys an industrial mixer for twenty thousand pounds. It is expected to mix one hundred thousand loaves of bread in its lifetime. If the bakery bakes ten thousand loaves this year, depreciation is two thousand pounds.
Example
A delivery courier purchases a van for fifteen thousand pounds, rated for one hundred and fifty thousand miles. If the van travels fifteen thousand miles in its first year, the business records fifteen hundred pounds of depreciation.
Example
A boutique printing press acquires a digital printer costing thirty thousand pounds, designed to print three hundred thousand pages. Printing thirty thousand pages in a quarter incurs three thousand pounds of depreciation.
Think of it
“Think of a car lease where you pay a flat rate per mile driven rather than a monthly fee. If you leave the car in the garage, you pay nothing. If you drive across the country, your costs go up accordingly.
Formula
Calculation
Depreciation Expense = (Cost minus Salvage Value) divided by Total Estimated Units, multiplied by Units Produced This Period. For example, a machine costs ten thousand pounds, has a one thousand pound salvage value, and is rated for nine thousand units. If it produces one thousand units this year, the expense is ((10,000 - 1,000) / 9,000) * 1,000 = 1,000 pounds.Case study
Seen in the real world.
Apex Manufacturing purchased a heavy stamping press for fifty thousand pounds, estimating it would stamp five hundred thousand metal plates before retirement. The salvage value was set at five thousand pounds. In its first year, demand was high, and the press produced one hundred thousand plates. Using the units of production method, Apex calculated the depreciation rate as forty five thousand pounds of depreciable base divided by five hundred thousand plates, equalling nine pence per plate. Multiplying this rate by the one hundred thousand plates produced resulted in a first-year depreciation expense of nine thousand pounds. In the second year, market demand slowed down, and the press produced only forty thousand plates, leading to a much lower depreciation expense of three thousand six hundred pounds. This approach allowed Apex to match its machinery costs accurately to its fluctuating production revenue.
Watch out
Common mistakes.
- Failing to update total estimated lifetime output when machine efficiency changes.
- Forgetting to subtract the estimated salvage value before calculating the rate per unit.
- Applying this method to assets that degrade primarily through aging rather than physical use.
Questions
People also ask.
When should I choose this method over straight-line depreciation?
Use it when asset usage fluctuates significantly and wear and tear depends directly on output rather than time.
What happens if my production estimate is wrong?
You adjust the rate prospectively in the period you discover the change, applying the new estimate to the remaining book value.
Can I use this method for tax purposes?
Tax authorities often have strict rules on depreciation methods, so check local tax regulations before applying this for tax filings.
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