# Unit of Production Method Definition | How Depreciation is Calculated

If you are a business owner with depreciating assets, you’ll want to be familiar with the term, unit of production method, or the units of activity method. You’ll likely overhear this type of language when dealing with your accountant, as it is commonly used for bookkeeping or tax purposes .  While there are several ways of calculating an asset’s depreciation value, the unit of production method is particularly useful when an asset's value is better defined by the number of units it produce, versus the number of years it is used.  A good example would be manufacturing machinery or a t-shirt printing machine. What do these items have in common? Each one of them has a pretty well-defined estimate on the practical usage to be expected during a period of time.  Before we go too far, let's review a list of important key terms you’ll want to understand.

### Depreciation

The decrease in the value of an asset over its lifetime is known as depreciation. In accounting terms, that means spreading the cost of an asset over a specific period of time.

### Salvage Value

Salvage value is an estimate determined by the book value after the depreciation of an asset is complete. It defines your asset’s value based on what you can expect to receive for selling the asset at the end of its useful life.

### Cost Basis

Cost basis is usually the purchase price or the total amount originally invested, including commissions or fees.

### Depreciable Cost

The depreciable cost refers to the cost basis of the asset, subtracted by the estimated salvage value at the end of its useful life.

## How Depreciation is Calculated

Depreciation is actually quite simple to calculate using the unit of production method. Now that you are familiar with the terms, you’ll simply want to plug in the correct criteria. Before you begin, you will need to gather several pieces of information such as, the cost of the asset and the estimated number of units expected to produce over its useful life. Let’s break it down: First, estimate the total number of units it will produce over its useful life. Next subtract the estimated salvage value from the cost basis of the asset, and divide the total estimated production from the depreciable cost. That will give you the depreciation cost per unit of production. Then you multiply the units of actual production by the units of production rate, which gives you the total depreciation expense. Unit of production depreciation expense formula:

1. (Cost basis – salvage value) / Estimated units produced during the useful life = Units of production rate
2. Actual units produced X Units of production rate = Depreciation expense

Don’t let the formula scare you; it’s much more simple than you think! Once you know the associated values, it’s simple to do the math. Here is an example of how to calculate the unit of production depreciation expense for a t-shirt printing machine in one year: Susan recently purchased a t-shirt printing machine for \$10,000, and it is estimated to produce 210,000 units over its14-year useful life. The actual units produced by the machine in the first year is 15,000, and the salvage value for the machine is \$1,000. Referring back to the steps above

1. (\$10,000 – \$1,000) / 210,000 = .043
2. 15,000 X .043 = \$645

Just like anything else, the unit of production method has its advantages and disadvantages. We’ll go over a couple of the important ones so you can decide for yourself it’s a good fit.

• Very accurate for showing actual wear and tear on an asset than other models that use a time-based approach.
• Clearly depicts business revenues and expenses as it is based on asset usage and fluctuates with demand.
• Helps track profits and losses for bookkeeping