How to Calculate Depreciation Per Unit

Depreciation is an accounting method that allocates the cost of a tangible asset over its useful life, recognizing that assets lose value due to wear, obsolescence, or usage. This allocation helps businesses match the asset’s expense with the revenue it generates. Unlike time-based methods, depreciation per unit ties the expense directly to an asset’s actual output or activity. This method is relevant for businesses that rely on assets whose value diminishes primarily through production or usage.

Understanding Depreciation Per Unit

Depreciation per unit, also known as the units-of-production method, allocates an asset’s cost based on the total number of units it is expected to produce throughout its operational life. This method recognizes that an asset’s decline in value is often more closely linked to its physical usage or output than to the length of time it has been owned. Consequently, the depreciation expense recognized each period fluctuates with the asset’s actual production volume.

This approach is especially useful for assets where wear and tear is a direct consequence of their operation, such as manufacturing machinery, vehicles, or equipment used in natural resource extraction. The underlying principle is that the asset’s economic benefit is consumed as it produces goods or services. Therefore, aligning the expense with this consumption provides a more accurate representation of the asset’s true cost of operation in any given period.

Gathering Necessary Information

Before calculating depreciation per unit, several specific pieces of information about the asset must be accurately determined. The asset’s original cost includes not only the purchase price but also all necessary expenditures to get the asset ready for its intended use.

The estimated salvage value represents the asset’s expected residual value at the end of its useful life. This is the amount a business anticipates receiving from selling or disposing of the asset after it is no longer useful for its primary purpose.

Estimating the total productive units the asset is expected to generate over its entire useful life is also crucial. This could be measured in machine hours, total miles, or the total number of items produced, depending on the asset type. Finally, the actual units produced in a specific accounting period must be tracked, as this figure will directly determine the depreciation expense for that period.

Step-by-Step Calculation

The calculation of depreciation per unit involves a three-step process.

The first step is to determine the depreciable base of the asset. This is calculated by subtracting the estimated salvage value from the asset’s original cost, representing the total amount that will be expensed over the asset’s useful life. For example, if an asset costs $100,000 and has an estimated salvage value of $10,000, its depreciable base is $90,000.

The second step involves calculating the depreciation rate per unit. This rate determines how much of the asset’s cost is allocated to each unit produced. It is found by dividing the depreciable base by the estimated total productive units over the asset’s entire life. Using the example, if the asset is expected to produce 300,000 units over its lifetime, the depreciation rate would be $90,000 divided by 300,000 units, resulting in $0.30 per unit.

The final step is to calculate the periodic depreciation expense for a specific accounting period. This is achieved by multiplying the depreciation rate per unit by the actual number of units produced during that period. If, in a given year, the asset produced 50,000 units, the depreciation expense for that year would be $0.30 per unit multiplied by 50,000 units, totaling $15,000. This calculation directly links the expense to the asset’s operational activity.

Practical Applications

The depreciation per unit method finds its most appropriate application in industries where an asset’s wear and tear is directly tied to its output rather than the passage of time. Manufacturing operations frequently use this method for machinery, as the asset’s useful life is often consumed by the number of products it manufactures. For instance, a stamping machine’s value diminishes with each part it presses, making a unit-based depreciation calculation more reflective of its consumption.

In the transportation sector, vehicles like delivery trucks or taxis often depreciate based on miles driven or hours operated, which aligns with the actual usage and physical wear. Similarly, in natural resource industries, such as mining, oil and gas extraction, or timber harvesting, assets like drilling rigs or logging equipment are often depreciated based on the volume of resources extracted. This method accurately reflects that the asset’s economic benefit is consumed as the resource is depleted.

This method also offers benefits by aligning expense recognition with revenue generation, adhering to the matching principle of accounting. By linking depreciation directly to production, businesses can achieve a more accurate reflection of their operational costs, especially during periods of varying production levels. This provides management with better insights into the true cost of producing goods or services, aiding in more informed internal decision-making regarding pricing and asset utilization.