Depreciation Methods: Straight-Line to Units of Production

Introduction

Union Pacific depreciates its locomotives, freight cars and buildings on a straight-line basis over estimated service lives measured in years. Its rail is different: in high-density traffic corridors, the company measures the rail's service life not in years but in millions of gross tons carried per mile, so depreciation follows how heavily the track is used. And because it owns a large base of similar, network-type assets, from rail to crossties, it depreciates them in groups at composite rates rather than one by one. In 2025, those methods produced $2.5 billion of depreciation expense.

A depreciation method decides the pattern in which an asset's cost reaches the income statement. Every method expenses the same total, the cost less any salvage value, over the asset's life; they differ only in timing. Choosing between them is a judgment about how an asset's benefits are consumed, and it affects operating income, net income and asset values in every year of the asset's life, while leaving cash untouched, because the tax return follows its own depreciation rules. The statement effects of depreciation itself are traced in depreciation on the three statements.

Depreciation method

The systematic pattern used to allocate the depreciable cost of an asset, its cost less estimated salvage value, over its useful life. It should reflect the pattern in which the asset's economic benefits are expected to be consumed, and it changes the timing, not the total, of depreciation expense.

Four methods cover nearly all practice:

Straight-line is by far the most common method in US financial statements, as PwC's property, plant and equipment guide notes. It is simple, it suits assets whose benefits arrive fairly evenly, and it produces stable earnings. Declining balance methods apply a constant rate, often double the straight-line rate, to the asset's remaining book value, so charges are highest in the first year and fall each year after. Sum-of-the-years' digits produces a similar front-loaded pattern with a steady decline. Units of production ties each period's charge to output, so depreciation rises and falls with activity.

Double-declining balance

An accelerated depreciation method that applies twice the straight-line rate to an asset's net book value at the start of each period. Charges are highest in the first year and decline afterwards, and companies usually switch to straight-line once it gives a larger charge.

Choosing a Method

Accounting Standards Codification (ASC) 360 requires only that depreciation allocate cost in a systematic and rational manner; in practice, companies pick the method that best matches how the asset's benefits are used up. An asset used evenly, such as an office building, suits straight-line. One whose usefulness drops sharply early, such as some technology equipment, is a candidate for an accelerated method, although many technology companies still use straight-line and capture the faster obsolescence through shorter lives instead. An asset worn out by use rather than time, such as a mining truck or heavily used track, suits units of production. Once chosen, a method is applied consistently to similar assets, and the lives and salvage values that go with it are the other half of the estimate, covered in useful lives and salvage values.

Suppose a company buys equipment for $1,500 with a five-year life and no salvage value, expected to produce 100,000 units over its life, with production of 30,000, 25,000, 20,000, 15,000 and 10,000 units in the five years:

The differences lie entirely in timing. Double-declining balance charges $600 in year one, twice the straight-line amount, and only $162 in each of the last two years; units of production follows the falling output. In year one, the choice of method moves pre-tax income by as much as $300 for an asset that cost $1,500, and in year five it moves it the other way. For a company with a large, steadily replaced asset base, the year-to-year differences tend to even out across the portfolio, but for a growing company, accelerated methods keep reported depreciation persistently higher than straight-line would.

Group and Composite Depreciation

Companies with very large numbers of similar, low-value assets, such as railroads, utilities and telecom networks, often depreciate them as a pool rather than individually. Under the group method, items with similar characteristics and lives are combined into asset classes and depreciated at a single composite rate, determined through periodic depreciation studies; the composite method applies the same pooling to closely related assets with different lives. Union Pacific's 2025 annual report treats each class as a pool of resources rather than as individual items, and recognizes no gain or loss when property is retired or replaced in the ordinary course of business: the cost of a retired item is simply removed from both gross property and accumulated depreciation. Gains and losses appear only for retirements that are unusual, material and out of line with the retirement pattern the studies predict.

Union Pacific's treatment of its rail combines both ideas. For rail in its high-density traffic corridors, every line except yard tracks, switching tracks and lines subject to abandonment, lives are measured in millions of gross tons per mile rather than in years, and the depreciation rate is recalculated each year from the gross ton-miles actually carried, so a line carrying more traffic wears out, and is depreciated, faster. In effect, this is units of production applied to a pool of assets: a sustained rise in freight volumes raises depreciation even before any new track is laid.

The method affects reported profit, not cash. In the example, the company spends $1,500 on day one whatever method it chooses. What changes is when the expense reduces operating income, net income and the ratios built on them, such as margins, return on assets and earnings per share. Earnings before interest, taxes, depreciation and amortization (EBITDA) is unaffected by definition, because it excludes depreciation.

Cash taxes depend instead on the depreciation claimed on the tax return, which in the United States follows its own rules. The return uses the Modified Accelerated Cost Recovery System, which, under IRS Publication 946, depreciates most equipment on a 200% declining balance schedule over prescribed recovery periods, and bonus depreciation can allow the full cost of qualifying equipment to be deducted in the first year. Because most companies use straight-line for their books and accelerated schedules for tax, tax depreciation runs ahead of book depreciation in the early years, cash taxes fall below tax expense, and a deferred tax liability builds up, the mechanism explained in deferred taxes on the three statements.

For analysis, the depreciation method is a comparability question. Two companies with identical assets can report different operating income in any year if one uses straight-line and the other an accelerated or usage-based method, so bankers check the property note before comparing margins on earnings before interest and taxes (EBIT) or returns on capital. They pay particular attention to:

In oil and gas, reserves are depleted on the same units-of-production logic, covered in the Energy guide's article on depreciation, depletion and amortization by units of production.

Whatever the method, the cost being spread is set by the capitalization rules that determine an asset's cost basis, and the total charged over the asset's life is fixed. The method decides only whether that total reaches the income statement early, late or in step with use, and that timing is what bankers adjust for when they compare one company's earnings with another's.