The units of production depreciation method calculates an asset’s expense based on how much work it does in a period rather than how many months have passed. You figure a per-unit rate once, then multiply it by the actual output each period. Heavy-use months carry a larger charge; slow months carry a smaller one. The result is a depreciation figure that tracks real wear instead of a flat annual number.
The Formula
Three inputs drive the calculation:
- Total cost of the asset, including purchase price, shipping, installation, and any testing needed to get it running.
- Estimated salvage value, meaning what the asset will be worth when you retire it, whether sold for parts or scrap.
- Total expected production capacity over the asset’s working life, measured in whatever unit fits the equipment (items produced, miles driven, hours run).
Subtract salvage value from total cost to get the depreciable base. Divide the base by total estimated capacity to get a per-unit rate. Multiply the per-unit rate by actual output for the period to get that period’s depreciation expense.
In one line: (Cost − Salvage) ÷ Total estimated units = Rate per unit, and Rate per unit × Units produced this period = Depreciation expense.
Worked Example
A company buys a stamping machine for $250,000. It expects the machine to be worth $50,000 at retirement, and the manufacturer rates it for 400,000 total units of output.
The depreciable base is $200,000 ($250,000 − $50,000). Dividing by 400,000 units gives a rate of $0.50 per unit.
- Year 1: the machine stamps 80,000 units. Expense = 80,000 × $0.50 = $40,000.
- Year 2: demand picks up and it produces 120,000 units. Expense = $60,000.
- Year 3: a slow year at 50,000 units. Expense = $25,000.
Each year’s charge reflects actual production, not an arbitrary time allocation.
The Salvage Value Floor
You can never depreciate an asset below its estimated salvage value, even if it keeps producing. Say the stamping machine has accumulated $195,000 in depreciation and the next period’s calculated expense would be $10,000. You can only record $5,000, because that’s what brings the book value exactly to the $50,000 floor. Any production after that generates no additional depreciation expense. Track the running book value each period so you don’t overshoot.
Which Assets Fit
This method fits assets whose value erodes through use. Manufacturing equipment that stamps, molds, or packages a countable output is the textbook case. Vehicles measured by mileage or flight hours work well too, because a truck with 300,000 miles is worth far less than one with 50,000 regardless of age.
Buildings, office furniture, and computers don’t fit. Their value declines from age and obsolescence whether anyone uses them or not. A desk doesn’t wear out faster because more people sat at it. Straight-line depreciation is the better match there.
One more limit: if an asset sits completely idle, this method records zero depreciation. A machine parked in a warehouse is still losing value to rust and obsolescence, and units-of-production won’t capture that. If your equipment spends long stretches unused, the method will understate its true economic decline.
Natural Resources
Oil wells and mines use a close cousin called depletion. The math is nearly identical: divide the acquisition cost by the estimated reserves, then multiply by actual extraction. Salvage value is usually zero because the resource is fully consumed, and extracted material typically hits inventory rather than expense until it’s sold.
Units-of-Production vs. Straight-Line
Straight-line spreads the depreciable base evenly across a set number of years. It’s simpler and it ignores usage patterns entirely. If a machine sits idle for six months and then runs double shifts for six, straight-line records the same expense every month. Units-of-production captures that unevenness and gives a more honest picture of when the asset is actually being consumed.
The tradeoff is bookkeeping. You need reliable production data every period, and someone has to watch the salvage floor. For assets with steady, predictable use, straight-line gets you close to the same answer with far less effort. Units-of-production earns its keep on equipment with uneven demand or precise output measurement, like injection molds with shot counters or trucks with odometers.
When Your Estimates Change
Production estimates are educated guesses. A machine rated for 400,000 units might show signs of lasting 500,000, or it might develop problems that cap its life at 300,000. Under generally accepted accounting principles, you handle revised estimates prospectively: adjust the per-unit rate going forward using the remaining depreciable base and the new capacity estimate. You don’t restate prior years.
Back to the stamping machine. After two years it has produced 200,000 units and accumulated $100,000 in depreciation. Engineers now estimate 300,000 remaining units instead of 200,000. The new rate becomes $100,000 ÷ 300,000 = $0.333 per unit. Prior periods stay as reported, because the original estimate was reasonable with the information available at the time.
Federal Tax Treatment
For tax purposes, the IRS generally requires businesses to depreciate tangible property using the Modified Accelerated Cost Recovery System (MACRS), which assigns each asset class a fixed recovery period in years. MACRS is time-based and doesn’t care how many units your machine stamped last quarter.
There is an explicit escape hatch. Under Section 168(f)(1), a taxpayer can elect to exclude property from MACRS if the property is depreciated using the units-of-production method (or another method not expressed in years), starting in the first taxable year a depreciation deduction is allowable for that property.1Office of the Law Revision Counsel. 26 U.S. Code 168 – Accelerated Cost Recovery System The election must be made on the return for the year the asset is placed in service. Miss that window and the asset defaults into MACRS.
If you already have an asset on MACRS and want to switch, the IRS treats it as a change in accounting method. You file Form 3115 with Schedule E attached to a timely filed return, and a signed copy goes to the IRS National Office. Whether a user fee applies depends on whether the change qualifies as automatic.2Internal Revenue Service. Instructions for Form 3115 (Rev. December 2022)
Getting the Estimate Wrong
An inflated capacity estimate leads to understated depreciation, which can create a tax underpayment. The IRS can impose an accuracy-related penalty of 20% on the underpaid amount when the adjusted basis claimed on a return is 150% or more of the correct amount, provided the resulting underpayment exceeds $5,000 ($10,000 for most corporations). If the overstatement reaches 200% or more of the correct value, the penalty doubles to 40%.3Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
Keep records of how you built the original estimate: manufacturer specifications, engineering assessments, and historical data from similar equipment. A reasonable estimate that turns out wrong is treated differently than a baseless one.