The units of production depreciation method calculates the annual depreciation expense of property, plant and equipment based on its usage. For this reason the production depreciation method is sometimes referred to as the units of activity depreciation method, the usage method of depreciation or the units of output method.
Usage can be defined as any unit measure such as the number of units produced, number of hours used, or number of miles driven, and the depreciation expense for a particular accounting period will depend on the quantity of that unit measure consumed during the period.
Units of Production Depreciation Method Formula
The units of production depreciation formula calculates the depreciation rate as follows:
The depreciation expense for the period is then based on the depreciation rate and the number of units produced during the period.
The method is in fact very similar in calculation to the straight line method of depreciation, except that the estimated useful life is defined in terms of the total expected usage instead of a time period in years.
Units of Production Depreciation Example
Suppose, for example, a business has purchased production equipment costing 20,000 and expects it to have a useful life 50,000 units of production and an estimated salvage value of 4,000, then the units of production depreciation calculation using the formula above would be as follows:
Units of production depreciation = (Cost - Salvage Value) / Lifetime in units Units of production depreciation = (20,000 - 4,000) / 50,000 Units of production depreciation = 0.32 per unit of production output
If during the first accounting period the equipment produced 13,500 units, then the calculation of the depreciation expense for the accounting period is as follows.
Units of production depreciation = 0.32 x Production units for the period Units of production depreciation = 0.32 x 13,500 Units of production depreciation = 4,320
Using the units of production depreciation method, the depreciation expense will be different each year depending on the level of usage of the equipment. Suppose in the above example the production output in year 2 was 25,000 units and in year 3, 11,500 units, then the depreciation expense each year would be as follows:
After the equipment has produced 50,000 units the total accumulated depreciation would be 16,000 (0.32 x 50,000), and the equipment’s net book value would be the salvage value of 4,000.
The diagram below sets out an analysis of the units of production depreciation method.
Units of Activity Depreciation Example
Instead of units of production output, the equipment might be depreciated using an alternative unit such as miles driven. Although the type of units change, the method of calculation remains the same. As an example, suppose equipment costing 30,000 with a salvage value of 5,000 has an expected useful lifetime of 40,000 miles, then the units of activity depreciation calculation using the formula above would be as follows:
Units of activity depreciation = (Cost - Salvage Value) / Lifetime in units Units of activity depreciation = (30,000 - 5,000) / 40,000 Units of activity depreciation = 0.625 per mile driven
If during the accounting period the equipment was driven for 18,000 miles, then the depreciation expense for the accounting period would be calculated as follows:
Units of activity depreciation = 0.625 x Miles driven in the period Units of activity depreciation = 0.625 x 18,000 Units of activity depreciation = 11,250
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.