Legal Definitions - units-of-production method

The units-of-production method is an accounting technique used by businesses to calculate how an asset's value decreases (depreciates) over time. Instead of spreading the cost evenly across the asset's useful life, this method ties the depreciation expense directly to the asset's actual usage or output. Businesses first estimate the total number of units an asset will produce or the total amount of work it will perform throughout its entire operational lifespan. They then allocate a specific portion of the asset's initial cost as depreciation for each unit produced or each hour it operates. This approach is particularly suitable for assets whose wear and tear is more closely linked to their activity level rather than simply the passage of time.

• Example 1: Industrial Printing Press

  A commercial printing company, "PageTurner Prints," purchases a new industrial printing press for $750,000. Based on the manufacturer's specifications and historical data, they estimate the press will produce a total of 15 million pages over its useful life. Using the units-of-production method, the company calculates a depreciation rate of $0.05 per page ($750,000 / 15,000,000 pages). In its first year of operation, the press prints 2.5 million pages. Therefore, the depreciation expense recorded for that year would be $125,000 (2,500,000 pages * $0.05/page). If in the second year, the press prints only 1.8 million pages due to lower demand, the depreciation expense would be $90,000 (1,800,000 pages * $0.05/page).

  How this illustrates the term: This example demonstrates how the depreciation expense for the printing press directly fluctuates with its actual output (number of pages printed). The asset's cost is allocated based on its productive use, rather than a fixed amount each year, reflecting that the press wears out more when it's actively printing.

• Example 2: Heavy Construction Excavator

  A construction firm, "GroundUp Builders," acquires a large excavator for $400,000. Engineers estimate the excavator will operate for a total of 10,000 hours before needing major replacement. The company establishes a depreciation rate of $40 per operating hour ($400,000 / 10,000 hours). In a busy year, the excavator is used for 1,200 hours on various projects, leading to a depreciation expense of $48,000 (1,200 hours * $40/hour). In a slower year, it might only be used for 700 hours, resulting in a depreciation expense of $28,000 (700 hours * $40/hour).

  How this illustrates the term: Here, the depreciation of the excavator is tied to its operational usage (hours worked). The units-of-production method accurately reflects that the machine's wear and tear, and thus its loss of value, is directly proportional to how many hours it is actively performing construction tasks.