The term units-of-output depreciation refers to one of several methods of allocating the cost of an asset over its expected lifetime. The units-of-output depreciation method is based on the assumption the asset will output a fixed number of units over its lifetime; therefore, the depreciation expense in a given accounting period is directly related to the asset's output in that same accounting period.
Units-of-Output Depreciation = (Cost of Asset - Residual Value) / Total Units of Output
Depreciation Expense = Units of Output Depreciation x Units Produced
The units-of-output depreciation method is based on the assumption an asset will produce a fixed number of units over its lifetime. The loss in value of the asset (depreciation expense) during an accounting period is directly related to the output of the asset in that same accounting period.
Depreciation is an accounting method of cost allocation. It is used to allocate the cost of an asset over its useful life. It's also referred to as a non-cash expense because the cash used to buy the asset left the company when it was purchased. Depreciation allows the cost of a balance sheet item (an asset) to flow smoothly to the income statement (an expense) over its serviceable life.
Company A purchases a backup generator for $200,000. The estimated serviceable life of the generator is expected to be 5,000 hours. The generator is projected to have a scrap value of $50,000 at the end of its serviceable life. In the current accounting period, the generator ran for approximately 300 hours.
Company A would create an asset on its balance sheet for $200,000 in Year 0. In the current accounting period, the company would depreciate the asset using the units-of-output method as follows:
The first step is to calculate the depreciation expense per hour:
= ($200,000 - $50,000) / 5,000 hours
= $150,000 / 5,000 hours, or $30 per hour
This value is then multiplied by the hours of operation in the current accounting period to determine the depreciation expense:
= $30 per hour x 300 hours, or $9,000