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. 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.
In practice
Real-world examples
Example 1
A bakery buys an industrial mixer for $20,000. It is expected to mix 100,000 loaves of bread in its lifetime, ignoring salvage value for simplicity. If the bakery bakes 10,000 loaves this year, depreciation is $2,000, which is matched against the bread sold in the same year.
Example 2
A delivery courier purchases a van for $15,000, rated for 150,000 miles with no salvage value. If the van travels 15,000 miles in its first year, the business records $1,500 of depreciation. In a quieter year of 6,000 miles, the charge would drop to $600.
Example 3
A boutique printing business acquires a digital printer costing $30,000, designed to print 300,000 pages. Printing 30,000 pages in a quarter incurs $3,000 of depreciation, or $0.10 per page. The owner adds this cost to the price of each print job to make sure every job covers its share of the machine.
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 - Salvage Value) / Total Estimated Units x Units Produced This Period
Example 1:
A machine costs $10,000, has a salvage value of $1,000 and is rated for 9,000 units. It produces 1,000 units this year.
Depreciation rate per unit = (10,000 - 1,000) / 9,000 = $1.00 per unit
Depreciation Expense = 1.00 x 1,000 = $1,000
Example 2 (changing activity levels):
Year 2 is busier and the machine produces 2,500 units. Depreciation = 1.00 x 2,500 = $2,500.
Year 3 is quiet and it produces 400 units. Depreciation = 1.00 x 400 = $400.
After three years, accumulated depreciation is 1,000 + 2,500 + 400 = $3,900, so the book value is 10,000 - 3,900 = $6,100, still above the $1,000 salvage value.
Straight-line depreciation over a 9-year life would have charged a flat $1,000 each year, regardless of activity.Case study
Seen in the real world
This is a fictional, illustrative scenario. Apex Manufacturing purchased a heavy stamping press for $50,000, estimating it would stamp 500,000 metal plates before retirement. The salvage value was set at $5,000. In its first year, demand was high, and the press produced 100,000 plates. Using the units of production method, Apex calculated the depreciation rate as $45,000 of depreciable base divided by 500,000 plates, equalling $0.09 per plate.
Multiplying this rate by the 100,000 plates produced resulted in a first-year depreciation expense of $9,000. In the second year, market demand slowed down, and the press produced only 40,000 plates, leading to a much lower depreciation expense of $3,600. This approach allowed Apex to match its machinery costs to its fluctuating production revenue. After two years, accumulated depreciation was $12,600 and the press had a book value of $37,400, with 360,000 plates of estimated life remaining. The illustrative finance team reviewed the output estimate each year, so that if the press proved able to stamp more plates than expected, the rate per plate could be adjusted for future years.
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.