Unit of Production

Unit of Production Method

The unit of production method depreciates an asset based on its actual usage or output rather than time. It’s most appropriate for assets whose wear and value loss correlate directly with production (for example, manufacturing equipment, vehicles measured by mileage, or mining equipment measured by tons extracted). This method matches depreciation expense to periods of high and low activity, yielding larger deductions in busy years and smaller ones in slow years.

Key takeaways

• Depreciation is based on units produced (or hours used), not years in service.
• Best for assets whose decline in value depends on usage.
• Produces variable annual expense that reflects actual wear and tear.
• Requires a reliable estimate of total production capacity; administrative tracking is necessary.
• For tax purposes in the U.S., MACRS is the default, but taxpayers may elect an alternative method (see IRS Publication 946).

Formula

Depreciation expense for a period:
Depreciation Expense = ((Cost − Salvage Value) / Estimated Total Units) × Units Produced in Period

Where:
* Cost = original purchase price (including installation and setup as applicable)
Salvage Value = estimated residual value at end of useful life
Estimated Total Units = total expected production over the asset’s useful life
* Units Produced in Period = actual units produced (or hours/miles used) during the accounting period

Step-by-step calculation

1. Estimate the asset’s total production capacity over its useful life.
2. Subtract salvage value from cost to get the depreciable base.
3. Divide the depreciable base by the estimated total units to get depreciation per unit.
4. Multiply depreciation per unit by the actual units produced in the period.

Example:
* Cost: $100,000
Salvage value: $10,000
Estimated total units: 200,000 units
* Units produced this year: 30,000 units

Depreciation per unit = (100,000 − 10,000) / 200,000 = $0.45 per unit
Annual depreciation = 0.45 × 30,000 = $13,500

When to use it

Use the unit of production method when:
* Asset wear and productivity are driven primarily by usage, and
* You can reasonably estimate total production capacity and reliably measure actual use.

Common examples: manufacturing presses (parts produced), delivery trucks (miles), drilling rigs (barrels/tons).

Advantages

• Matches expense to actual economic use, improving income measurement.
• Provides tax relief in high-production years (larger deductions when needed).
• More accurate for usage-driven assets than time-based methods.

Disadvantages

• Requires accurate estimates of total production and consistent tracking of usage.
• Year-to-year depreciation can be volatile, complicating budgeting and forecasting.
• May not align with default tax depreciation schedules (see MACRS below).

Unit of Production vs. MACRS

The Modified Accelerated Cost Recovery System (MACRS) is the standard U.S. tax depreciation system that allocates cost over preset recovery periods using declining-balance and straight-line techniques. MACRS is time-based and does not depend on actual production.

For tax reporting, businesses generally use MACRS but may elect an alternative method (such as unit of production) if it more accurately reflects the asset’s decline in value. Such an election must follow IRS rules and timing — consult IRS Publication 946 for details on elections and reporting.

Practical notes

• Depreciation begins when the asset is placed in service and producing units.
• Depreciation ends when the depreciable base is fully recovered or the estimated total units have been produced, whichever comes first.
• Reestimate total production if circumstances change materially; adjust future depreciation accordingly.

Final thoughts

The unit of production method offers a clear, use-based approach to depreciation that can improve the matching of expenses to revenues for production-driven assets. It delivers more accurate financial reporting when usage is the primary driver of wear, but it requires careful estimation and tracking. For tax treatment and elections, refer to relevant tax guidance before applying this method.

Source: IRS Publication 946, How to Depreciate Property.