Unit-of-Production Depreciation Explained With Examples
Depreciation spreads out the cost of an asset over time, but not all methods account for actual usage. The Unit-of-Production (or “Units of Production”) Depreciation Method ties equipment’s loss of value to how much it is used, making it more accurate for certain businesses. Here is how this method works and when it is the best choice.
What Is Unit-of-Production Depreciation?
Unit-of-Production Depreciation assigns depreciation expense based on how much an asset is used, not just how long it will be in service. This method is ideal when an asset's value is tied more closely to its usage than to time.
The key benefit is that depreciation aligns with actual production levels. In years with high usage, depreciation is higher; while in years of lower usage, it is lower. This method offers a more accurate financial picture of the asset’s value over time.
Benefits of Unit-of-Production Depreciation
The Unit-of-Production Depreciation Method ties depreciation directly to how much an asset is used. This means businesses can maximize deductions in high-production years when expenses are higher, reducing taxable income and improving cash flow. It helps businesses better manage costs and avoid overestimating asset values.
Industries that Benefit Most from this Method
Certain industries benefit the most from Unit-of-Production Depreciation because their assets wear down based on usage rather than time.
Manufacturing businesses with heavy machinery and production equipment benefit from this method because it matches depreciation with asset usage. This provides a more accurate picture of asset value.
Printing businesses with high-use copy machines and presses can apply this method based on pages printed or copies made. This ensures depreciation aligns with actual wear and tear.
Mining and natural resource industries also find it useful since equipment is often used based on extraction rates. The Unit-of-Production Method ensures that depreciation reflects the intensity of use.
Transportation companies that charge based on mileage or hours can benefit as well. Depreciation increases during periods of heavy usage, offering tax savings during busy times.
Airlines can base depreciation on flight hours or miles flown.
Equipment rental companies can track usage by hours operated or times rented.
Builders can depreciate construction equipment more heavily during peak periods of activity, helpful to offset taxable income.
Restaurants can depreciate kitchen equipment according to its use, offsetting part of the income produced by especially popular menu items.
How to Calculate Unit-of-Production Depreciation
Follow these steps to compute depreciation using the Unit-of-Production Method:
Step 1: Estimate the total number of units the asset will produce over its useful life.
Step 2: Subtract the estimated salvage value from the asset’s original cost.
Step 3: Divide this amount by the total estimated production capacity to determine depreciation per unit.
Step 4: Multiply the number of units produced in the accounting period by the depreciation per unit to calculate the depreciation expense for that period.
Tracking production data accurately is crucial to ensure proper depreciation calculations. A small business accounting professional can help you set up effective tracking systems and maintain compliance with IRS rules.
Unit-of-Production Depreciation Examples
The following are two examples that demonstrate how the Unit-of-Production Method works in different industries.
Manufacturing Equipment
A toy manufacturing company in Jacksonville, Florida, purchases a machine for $300,000. The machine is expected to produce 150,000 units over its useful life. Its salvage value is $15,000.
The total depreciable amount is $285,000 ($300,000 - $15,000). Depreciation per unit is $1.90 ($285,000 ÷ 150,000 units).
If the machine produces 12,000 units in the first year, depreciation for that year is $22,800 (12,000 × $1.90). If it produces 40,000 units in the next year, depreciation would be $76,000 (40,000 × $1.90). This process continues until total depreciation reaches $285,000.
Skid-Steer Rental
A Florida equipment rental business purchases a skid-steer loader for $50,000. The skid-steer is expected to be rented for 5,000 operating hours over its useful life. Its salvage value is estimated at $5,000.
The total depreciable amount is $45,000 ($50,000 - $5,000). Depreciation per hour of use is $9 ($45,000 ÷ 5,000 hours).
If the skid-steer is rented for 600 hours in the first year, depreciation for that year is $5,400 (600 × $9). If it is rented for 1,200 hours the next year, depreciation would be $10,800 (1,200 × $9). This continues until total depreciation reaches $45,000.
Unit-of-Production Depreciation vs Other Depreciation Methods
Different depreciation methods suit different types of assets, depending on how they lose value.
The Straight-Line Depreciation Method spreads depreciation evenly over an asset’s useful life. It is best for assets used consistently and is less accurate for high-usage assets.
Accelerated depreciation methods, like the Declining Balance Method, front-load depreciation allowing the business to recover a larger amount in the earlier years. It is ideal for assets that lose value quickly, such as technology.
The Unit-of-Production Method adjusts depreciation according to actual usage by estimating how many units can be produced during the asset’s useful life. This makes it the most suitable for equipment that wears down based on production levels, ensuring depreciation matches real asset use.
Schedule an appointment with our accounting professionals to find the most tax-efficient depreciation method for your business.
Potential Drawbacks of the Unit-of-Production Method
The Unit-of-Production Method offers more accuracy than other depreciation methods. However, tracking production data can be complex and time-consuming. If asset usage is consistent, the results may not differ much from straight-line depreciation, making the extra effort unnecessary.
For businesses that do not rely on detailed usage tracking for decision-making, this method may not be cost-effective. The trade-off between accuracy and increased record-keeping should be carefully considered with the help of an accounting professional.
How the IRS Treats Unit-of-Production Depreciation
Businesses can claim depreciation deductions using the Units-of-Production Method, but they must track actual production or usage data. Maintaining proper records is essential to comply with IRS guidelines. Many businesses opt for simpler methods due to their ease of calculation and standard tax reporting.
Is the Unit-of-Production Depreciation Right for Your Business?
The Unit-of-Production Depreciation Method provides a precise way to allocate asset costs based on usage. It benefits businesses with fluctuating production levels, offering greater tax efficiency and financial accuracy. However, proper tracking is essential to maximize its advantages.
Your choice of depreciation method impacts cash flow and tax planning. A small business accounting professional can help you determine whether the Unit-of-Production Method is the best fit and ensure full compliance with IRS documentation requirements.
