# Unit of Production Method: Depreciation Formula and Practical Examples

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*— Investopedia / Sydney Burns*

## What Is the Unit of Production Method?

The Unit of Production Method calculates depreciation based on an asset's output. This approach is ideal for assets where value loss correlates with consumption or wear from use, like manufacturing equipment. It offers greater accuracy compared to time-based methods, providing higher deductions in active years, which aids in aligning depreciation with actual wear and tear.

The unit of production method for [depreciation](https://www.investopedia.com/terms/d/depreciation.asp) becomes useful when an asset’s value is more closely related to the number of units it produces than to the number of years it is in use. This method often results in greater [deductions](https://www.investopedia.com/terms/d/deduction.asp) being taken for depreciation in years when the asset is heavily used, which can then offset periods when the equipment experiences less use.

This method can be contrasted with time-based measures of depreciation, such as [straight-line](https://www.investopedia.com/terms/s/straightlinebasis.asp) or [accelerated](https://www.investopedia.com/terms/a/accelerateddepreciation.asp) methods.

### Key Takeaways

*   The unit of production method calculates depreciation based on an asset's actual usage rather than its time in use.
*   This method is ideal for assets whose value is tied to production output, such as machinery and manufacturing equipment.
*   Depreciation under this method is higher during periods of intensive use, allowing businesses to offset higher operational costs.
*   Unlike the MACRS method, which uses a preset time schedule for depreciation, the unit of production method adjusts according to actual production.

## How to Calculate Depreciation Using the Unit of Production Method

Depreciation expense for a given year is calculated by dividing the original cost of the equipment less its [salvage value](https://www.investopedia.com/terms/s/salvagevalue.asp), by the expected number of units the asset should produce given its useful life. Then, multiply that quotient by the number of units (U) used during the current year.

﻿ $\begin{aligned} &\text{DE}=\left[\frac{(\text{Original Value}\ -\ \text{Salvage Value})}{\text{Estimated Production Capability}}\right ]\times\text{U}\\ &\textbf{where:}\\ &\text{DE}=\text{Depreciation Expense}\\ &\text{U} = \text{Units per year} \end{aligned}$﻿

## Insights from the Unit of Production Method

Essentially, the units of production depreciation expense claimed in a year is based upon what percentage of an asset’s production [capacity](https://www.investopedia.com/terms/c/capacity.asp) was used up during that year. This depreciation method can help companies take larger depreciation deductions in years when a given piece of equipment is more productive.

Companies claim depreciation on a piece of equipment or property for bookkeeping purposes, but also for tax deductions. Larger deductions in more productive years can help offset other, higher costs associated with higher production levels.

The unit of production method most accurately measures depreciation for assets where the [wear and tear](https://www.investopedia.com/terms/w/wear-and-tear-exclusion.asp) are based on how much they have produced, such as manufacturing or processing equipment. Using the unit of production method for this type of equipment can help a business keep track of its profits and losses more accurately than a chronology-based method such as straight-line depreciation or [MACRS](https://www.investopedia.com/terms/m/macrs.asp) methods.

The unit of production method depreciation begins when an asset begins to produce units. It ends when the cost of the unit is fully recovered or the unit has produced all units within its estimated production capacity, whichever comes first. 

## Comparing Unit of Production and MACRS Depreciation Methods

The modified accelerated cost recovery system (MACRS) is a standard way to depreciate [assets](https://www.investopedia.com/ask/answers/020215/what-assets-are-taxable-and-what-assets-are-not-taxable.asp) for tax purposes. Instead of being dependent on the number of units that an asset might produce, this depreciation method involves calculations that result in the asset’s value being depreciated with a declining balance for a set period of time, then switching to a straight-line depreciation method to finish the depreciation schedule.

For tax purposes, the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) requires businesses to depreciate property using the MACRS, but it allows businesses to exclude property from this method if it can be accurately depreciated by another method, such as the unit of production method. To use this method, the owner must elect exclusion from the MACRS by the return due date for the [tax year](https://www.investopedia.com/terms/t/taxyear.asp) when the property is initially placed into service. 

For more information regarding this election and the specifics of how to make the election, see [IRS Publication 946, How to Depreciate Property](https://www.irs.gov/publications/p946).

## How Is the Unit of Production Method Useful?

The unit of production method becomes useful when an asset’s value is more closely related to the number of units it produces than to the number of years it is in use.

## How Do I Calculate Units of Production?

Divide the original cost of the equipment, minus its salvage value, by the expected number of units the asset should produce given its useful life. Then, multiply that quotient by the number of units used during the current year. This calculates depreciation expense for a given year.

## How Does the Unit of Production Method Help Businesses?

The unit of production method can help companies take larger depreciation deductions in years when a given piece of equipment is more productive. The units of production depreciation expense claimed in a year is based upon what percentage of an asset’s production capacity was used up during that year.

## Final Thoughts on the Unit of Production Method

The unit of production method calculates the depreciation of an asset’s value over time. The method is useful when an asset’s value is more closely related to the number of units it produces than to the number of years it is in use. Greater deductions are often taken for depreciation in years when the asset is heavily used, which offsets periods when the equipment experiences less use.

> **Article Sources**
>
> 1.  Internal Revenue Service. “[Publication 946 (2023), How to Depreciate Property](https://www.irs.gov/publications/p946).”