How to Calculate Depreciation Expense Using Units of Production Method?

This method of charging depreciation on the asset is based on the units produced during the year. The estimated total production of the asset is the criteria for providing depreciation. Similarly, the unit of production method is a depreciation method used across various industries and business entities to systematically allocate asset costs. This article will go through the unit of production method, how it works with an example, and a comparison with other depreciation methods. The process of systematic allocation of an asset’s value over its’s useful life is called depreciation. There are different methods of depreciation that are used across different companies and for varying purposes.

• Unit of production method is a depreciation method of systematically allocating an asset’s cost.
• Such a method is useful where a company has many fixed assets with varying usage.
• Not all companies can use the units of production method to calculate depreciation.
• He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.
• Units of production is a depreciation method that relies on how heavily an asset is used by a company versus other standard depreciation methods that usually relies on a timeline.
• Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.

This can be helpful if you are trying to determine your costs with a high degree of accuracy. Unlike other depreciation methods, units of production depreciation—or units of activity depreciation, as it’s sometimes called—is not calculated based on the amount of time an asset is in service. Instead, units of production depreciation https://www.bookstime.com/ is calculated based on the use of the asset. This method can be time-consuming, so it’s typically used for more expensive assets because it requires that you track usage. Most tangible assets (besides land) that are used to operate a business can be used to show depreciation, such as buildings, vehicles, machinery, and equipment.

Explanation of Units of Production Method of Depreciation

Each Widget you produce using your WidgetMaker 3000 reduces the value of the machine by $0.10. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. We follow strict ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.

To use this method, the owner must elect exclusion from MACRS by the return due date for the tax year the property is initially placed into service. In this article, we’ve tried to explain the concept of ‘unit of production method’ and how companies can depreciate their assets based on machinery and equipment output. The unit of production method calculates the amount of asset’s value that has been lost upon its usage. However, other methods account for the depreciation over the financial period regardless of whether it was used.

Units of Production Depreciation: Definition and Formula

This is well suited for companies owning equipment and machinery that accumulates wear and tear depending on production. It’s a precise method of calculating depreciation but it’s a more laborious method. A company should determine units of production method definition whether the extra effort is worthwhile before adopting this depreciation method. Time is usually a key component of how to calculate depreciation of an asset (as seen in the straight line or the accelerated methods).

Each one of them has a pretty well-defined estimate on the practical usage to be expected during a period of time. However, the attempt to accurately depreciate an asset based on usage on a per unit basis also introduces more assumptions, resulting in more discretionary decisions (and more room for scrutiny from investors). This method is applied where the value of the asset is more closely related to the number of units it produces. Thus, in the years when the asset is heavily used, the amount of depreciation will be high.