Units of Production Depreciation: Formula, Example and When to Use It

How the method works

You estimate the total units an asset will produce over its life, then expense a share each period equal to the units it actually produced.

Most depreciation methods run on the calendar. Straight-line takes the same amount each year. Units of production runs on activity. Units can be miles driven, hours operated, pages printed or items made, whichever best measures wear.

The method needs three inputs: the asset's cost, its salvage value (what you expect to sell it for at the end), and its total expected output. The expense each period rises and falls with real use, which lines cost up with the revenue the asset helps produce. For the basic concept, see what depreciation is.

The formula step by step

Depreciation per unit equals cost minus salvage value, divided by total estimated units. Multiply that rate by units used in the period.

Use two steps:

1. Rate per unit = (Cost - Salvage value) / Total estimated units
2. Period expense = Rate per unit x Units used in the period

Choose the unit carefully. A delivery van is better measured in miles than in years. A commercial printer is better measured in pages or impressions. Pick something you can count accurately, because the method fails if your tracking is sloppy. Keep a usage log from day one.

A worked example

A $60,000 machine with $6,000 salvage value and 300,000 expected units depreciates at $0.18 per unit.

This is an illustrative example with round numbers. A bottling shop buys a machine for $60,000. It expects to sell it for $6,000 after producing 300,000 bottles.

Rate per unit = ($60,000 - $6,000) / 300,000 = $0.18 per bottle.

Notice the expense swings with volume. Straight-line over ten years would show $5,400 every year regardless. The shop that has a booming year 2 records more cost that year, when it also earned more revenue.

When it beats straight-line, and when it does not

Use it when wear follows output and output varies. Avoid it when assets lose value mainly through age or obsolescence.

Good fits:

• Production machinery with uneven demand
• Delivery vehicles or equipment used by mileage or hours
• Rental or project equipment used heavily in some seasons
• Mining, drilling and similar extraction assets

Poor fits include office furniture, buildings and computers, which age whether or not you use them. A computer that sits unused still becomes outdated. For those, straight-line or an accelerated approach is more honest. Also note that you must keep reliable usage records, and a bad estimate of total units skews every year.

Book depreciation versus tax depreciation

Units of production is generally an accounting method for your books. U.S. income tax filings typically use MACRS instead.

For federal income tax, most business property uses the IRS system covered in our MACRS guide, which assigns fixed recovery periods. Units of production usually appears in internal financial statements, lender reports or situations where the tax code allows flexibility.

Having two sets of numbers is normal. Your accountant tracks the difference. Do not use the book number on a tax return unless your accountant confirms it is allowed for that asset. Rules and elections change, so check with your accountant or the IRS for current guidance.

Keeping records the method needs

Track units used per period, the estimated lifetime total, and any revisions. Review the estimate yearly and adjust going forward.

Set up a simple log per asset. Record the start date, cost, salvage estimate and total expected units. Each month, add units used. A spreadsheet works. Many shops pull the number from machine counters, GPS mileage logs or fleet software.

If you learn that the machine will last longer or shorter than expected, revise the estimate and spread the remaining depreciable amount over the new remaining units. Do not rewrite past years. Clean records here also help when a funder reviews your financials, as covered in our piece on bookkeeping habits that help financing.

Using the numbers to decide on replacement equipment

Cost per unit tells you what each item of output costs in equipment wear, and helps you decide when replacement pays for itself.

The $0.18 per bottle figure is useful beyond the books. Add it to labor, materials and maintenance to see true cost per unit. If a newer machine brings the equipment cost to $0.15 and cuts labor by $0.05 per bottle, at 200,000 bottles a year you save about $16,000 annually, in this illustrative case. Weigh that against the payment.

When the math supports an upgrade, equipment financing through ROI Funder can fund in 2 to 7 days. Our team starts from what the equipment will produce and shows the true cost and monthly-equivalent payment before you sign. ROI Funder considers 500+ FICO, 6+ months in business and $20,000+ monthly revenue. Read more on using business loans for equipment upgrades.