Units-of-production depreciation

What it means

Units-of-production depreciation is a method of accounting depreciation in which the charge for a period is based on the asset's actual output rather than elapsed time. Output can be kilometres driven, machine hours, units produced or tonnes extracted. If a machine works more this year, the charge is higher; if it stands idle, the charge is low.

The calculation starts from an estimate of the total output the asset will deliver over its life. The depreciable amount is divided by that total, and the resulting rate per unit is multiplied by actual output in the period. For a lorry expected to cover 600,000 km, for example, the annual charge is based on the kilometres driven that year.

The method suits cases where wear reflects use more than the passage of time and where use is uneven. It is an alternative to straight-line depreciation, which charges the same amount every year regardless of use. The company sets the method in its depreciation schedule.

How it works in practice

The method is used mainly for vehicles, construction and agricultural machinery, production lines with seasonal utilisation or mining equipment. It requires reliable records of output, such as a mileage log, hour meter or production reports. Without them the charge cannot be calculated in a verifiable way.

Units-of-production depreciation applies to accounting only. For tax purposes Slovakia uses tax depreciation under the Income Tax Act, either straight-line or accelerated by depreciation group. The difference between accounting and tax depreciation is adjusted in the tax return and gives rise to deferred tax.

If the estimate of total output changes, for example after a major overhaul that extends the asset's life, the rate per unit is recalculated and the schedule changed prospectively. With component depreciation, the units-of-production method can be used for some components only, such as an engine, and the time-based method for the rest.

What to watch out for

The most common mistake is an unrealistic estimate of total output. If it is too high, depreciation is low and the asset stays on the books at a value it no longer has. If too low, the asset is written off before it actually wears out. The estimate should draw on manufacturer data and the company's own experience.

Beware of changing the method. Switching between time-based and units-of-production depreciation is a change in accounting estimate or policy that must be justified and described in the notes. Frequent changes without a substantive reason raise suspicion of earnings management and the auditor will examine them.