How to Calculate Depreciation Per Unit of Production

Depreciation is an accounting process used to allocate the cost of a tangible asset over its useful life. This systematic expensing of an asset’s value reflects its gradual wear and tear, obsolescence, or consumption as it contributes to generating revenue for a business. Among various methods, the “units of production” approach bases depreciation on an asset’s actual usage or output. This contrasts with time-based methods that spread costs evenly over a set period, regardless of how much the asset is utilized.

Understanding the Units of Production Method

The units of production method operates on the principle that an asset’s depreciation is directly tied to its activity levels. This means an asset will experience more depreciation when it is used extensively and less when its usage is low. This approach aligns the expense recognition with the actual economic benefit derived from the asset, providing a more accurate representation of its cost consumption.

This method is suitable for assets where wear and tear are directly linked to their output or activity. Examples include machinery that produces goods, vehicles measured by miles driven, or specialized equipment tracked by hours of operation. Unlike time-based depreciation methods, which might charge the same amount of depreciation whether a machine runs constantly or sits idle, the units of production method fluctuates with actual usage. It provides a variable expense that directly reflects the asset’s productivity.

Gathering Necessary Information

Before calculating depreciation using the units of production method, specific information about the asset is required.

First, determine the asset’s original cost, which includes the purchase price and all additional costs incurred to get the asset ready for its intended use. This can encompass shipping fees, installation charges, and testing costs. For instance, if a company buys a machine for $100,000, pays $5,000 for shipping, and $5,000 for installation, its original cost for depreciation purposes would be $110,000.

Second, estimate the asset’s salvage value. This represents the estimated resale value of the asset at the end of its useful life. This value is subtracted from the original cost to determine the total amount that will be depreciated.

Finally, estimate the total units of production the asset is expected to yield over its useful life. This represents the asset’s total capacity. For example, this could be the total number of items a machine is expected to produce, the total miles a vehicle is expected to travel, or the total hours a piece of equipment is anticipated to operate. This estimate helps determine how much of the asset’s value is consumed per unit of output.

Calculating the Depreciation Rate Per Unit

Once the necessary information is gathered, the first step is to determine the depreciation rate per unit. This rate represents the amount of depreciation expense incurred for each unit of output or usage. The formula for this calculation is: (Asset’s Original Cost – Estimated Salvage Value) / Total Estimated Units of Production.

The result provides a fixed depreciation cost for every unit the asset produces or every hour it operates. For example, if an asset cost $50,000, has an estimated salvage value of $5,000, and is expected to produce a total of 90,000 units, the depreciable amount is $45,000 ($50,000 – $5,000). Dividing this by 90,000 units yields a depreciation rate of $0.50 per unit. This rate will remain constant throughout the asset’s life.

Applying the Rate for Periodic Depreciation

After determining the depreciation rate per unit, the final step involves applying this rate to calculate the actual depreciation expense for a specific accounting period. This period could be a month, quarter, or year, depending on the business’s reporting cycle. The formula for calculating periodic depreciation is: Depreciation Rate Per Unit × Actual Units Produced in the Period.

This method results in varying depreciation expenses each period, directly reflecting the asset’s actual activity. For instance, if the depreciation rate per unit is $0.50 (as calculated previously) and the asset produced 10,000 units in a given month, the depreciation expense for that month would be $5,000 ($0.50 × 10,000 units). If in the next month, the asset produced 15,000 units, the depreciation expense would increase to $7,500 ($0.50 × 15,000 units). This direct correlation between usage and expense provides a highly accurate allocation of an asset’s cost over its working life.