“Units of Production” depreciation is based on an asset’s usage. This can be expressed in units produced, hours consumed and mileage driven. This method is used when an asset’s usage varies from year to year. This post provides just simple and easy step-by-step instruction on how to compute depreciation under units of production for each of the three variations [units produced, hours consumed and mileage driven].
Units Produced Method
Under the first variation of the “Unit Of Production” method, a fixed amount of depreciation is allocated to each unit of output produced by the machine. The per-unit depreciation expense is multiplied by the number of units produced in each accounting period.
This depreciation method accurately reflects the depreciation expense for the asset because it is based on the number of units produced in each period.
Depreciation per unit is computed in two following simple steps:
Step-1: Compute the “Depreciation Per Unit” with the following formula:
Depreciation per unit = [Cost of asset – scrap value]/ Total estimated units of output
Step-2: Compute the annual depreciation expense with the following formula:
Annual depreciation expense = Units produced × unit depreciation
EXAMPLE: If the cost of a machine is $17,000, its scrap value is $2,000 and its total estimated units produced during its lifetime is 300,000, then the depreciation is calculated as follows (assuming the following facts):
First year production = 25,000 units
Second year production = 30,000 units
Step-1: Compute the depreciation per unit:
Depreciation per unit = [$17,000 – $2,000]/ 300,000 = $0.05
Step-2: Compute depreciation expense for Year 1 & 2:
Year 1: 25,000 units × $0.05 = $1,250
Year 2: 30,000 units × $0.05 = $1,500
Hours Used Method
In the second variation of unit of production [the hours used method], a fixed amount of depreciation is allocated based on the number of hours the machine is used.
EXAMPLE: the depreciation for the following machines in the first year using the straight-line method and the unit of production hours of usage method is:
Machine A Machine B
Cost $22,000 $22,000
Scrap Value $ 2,000 $ 2,000
Estimated Life 5 years 5 years
(18,000 hours) (18,000 hours)
Machine A was in use for 3,000 hours in the first year
Machine B was in use for 1,000 hours in the first year
Step-1: Compute the depreciation using straight line method for the first year of usage
There fore the Straight Line Depreciation = $4,000 annual depreciation expense*
Note: *($22,000 – $2,000) / 5 years = $4,000
Step-2: Compute the depreciation using the unit of production method for the first year of usage
Unit Of Production Hours of usage = $1.11 annual depreciation expense*
*($22,000 – $2,000) / 18,000 hours = $1.11
1st year depreciation expense of Machine A=3,000 hours × $1.11 = $3,330
1st year depreciation expense of Machine B=1,000 hours × $1.11 = $1,110
The difference between the first-year depreciation using the straight line method and that using the unit of production method is considerable. Under the Units Of Production method, machine B’s limited use results in its having one-third the depreciation expense of machine A. Under the straight-line method, both machines carry the same depreciation expense, regardless of use. In this case, unit of production is the more logical choice for reporting depreciation because it more accurately matches expense against periodic income.
Under the third variation [mileage driven] of unit of production depreciation, instead of using time to calculate depreciation, the number of miles driven are the “units”. The depreciation expense per mile will remain constant over the life of the truck, and will be multiplied by the actual miles the truck is driven in each accounting period.
EXAMPLE: a truck costing $24,000 with a salvage value of $4,000 has an estimated useful life of 80,000 miles. If, in the first year, it is driven 18,000 miles, depreciation is calculated as follows:
[$24,000 (cost) – $4,000 (salvage value)] / 80,000 total estimated miles = $0.25 per mile
1st year depreciation expense = 18,000 (miles driven) × $0.25 = $4,500
Therefore, the journal entry for the depreciation expense would be: