The Machine Hour Method is a production-based depreciation technique that allocates an asset’s cost according to how intensely it is used. Unlike time-based methods such as Straight-Line or Reducing Balance, the Machine Hour Method links depreciation directly to output capacity. This makes it particularly suitable for manufacturing environments, engineering workshops, mining operations, printing presses, textile mills, and any industry where machine productivity determines economic benefit.
Under IAS 16 Property, Plant and Equipment, depreciation must reflect the pattern in which the asset’s future economic benefits are consumed. For machinery whose wear and tear depends primarily on operating hours, this method often provides the most accurate and compliant approach.
1. Understanding the Machine Hour Method
Definition
The Machine Hour Method depreciates a machine based on the actual number of hours it has operated during the accounting period. Businesses estimate the total productive hours the machine will run over its useful life and allocate depreciation proportionately.
Key Features:
- Depreciation varies each period based on usage.
- Higher machine usage results in higher depreciation expense.
- Provides a realistic charge for industries where machine workload fluctuates.
- Helps match revenue with the wear and tear incurred to generate it.
- Commonly used for CNC machines, lathes, turbines, compressors, drill presses, and production robots.
2. Formula for the Machine Hour Method
Depreciation per Machine Hour = (Cost of Asset − Residual Value) ÷ Total Estimated Machine Hours
Annual Depreciation = Depreciation per Machine Hour × Machine Hours Used
- Cost of Asset: Total cost including installation, delivery, testing, and commissioning.
- Residual Value: Expected value at the end of useful life.
- Total Estimated Machine Hours: The machine’s lifetime capacity.
- Machine Hours Used: Hours logged during the accounting period.
Important IFRS Note: IAS 16 requires the estimated useful life and consumption pattern to be reviewed annually. Machine hour estimations must be updated if production expectations change.
3. Example of the Machine Hour Method
Scenario:
A business purchases a high-precision CNC machine for $50,000. The estimated residual value is $5,000. The machine is expected to operate for 25,000 total hours. During the first year, it operates for 4,000 hours.
Step-by-Step Calculation:
Step 1: Depreciation Per Hour
($50,000 − $5,000) ÷ 25,000 hours = $1.80 per hour
Step 2: First-Year Depreciation
$1.80 × 4,000 hours = $7,200
This depreciation reflects the machine’s actual workload instead of the mere passage of time.
4. Depreciation Schedule Using the Machine Hour Method
| Year | Machine Hours Used | Depreciation Per Hour ($) | Depreciation Expense ($) | Accumulated Depreciation ($) | Book Value ($) |
|---|---|---|---|---|---|
| 1 | 4,000 | 1.80 | 7,200 | 7,200 | 42,800 |
| 2 | 5,000 | 1.80 | 9,000 | 16,200 | 33,800 |
| 3 | 3,500 | 1.80 | 6,300 | 22,500 | 27,500 |
| 4 | 6,000 | 1.80 | 10,800 | 33,300 | 16,700 |
| 5 | 6,500 | 1.80 | 11,700 | 45,000 | 5,000 (Residual Value) |
Depreciation naturally accelerates in years of higher production and slows in quieter periods.
5. Journal Entry for Machine Hour Depreciation
Each year, the following entry is recorded:
Journal Entry:
Debit: Depreciation Expense
Credit: Accumulated Depreciation
Example (Year 1):
Debit: Depreciation Expense $7,200
Credit: Accumulated Depreciation $7,200
This entry ensures expenses reflect the asset’s consumption of economic benefits, as required under IFRS.
6. Deep-Dive: Why the Machine Hour Method Is So Valuable
- Matches cost to output: Perfect for manufacturing environments that focus on per-unit or per-hour production cost analysis.
- Supports accurate product costing: Essential for businesses using job costing, batch costing, or process costing systems.
- Improves pricing decisions: More accurate depreciation inputs help determine product margins.
- Useful for budgeting: Plants operating round-the-clock need depreciation tied to workload, not calendar months.
- Ideal for performance measurement: Helps analyze productivity relative to machine wear and maintenance cycles.
Industry Example:
A textile factory operating looms 24 hours a day will find that straight-line depreciation greatly understates the cost of wear and tear during peak production months. The Machine Hour Method gives management a more realistic view of machinery costs per meter of fabric produced.
7. Disadvantages of the Machine Hour Method
- Requires precise hour tracking: Poor record-keeping will distort depreciation.
- Not suitable for all assets: Buildings, office furniture, or idle equipment do not benefit from this method.
- Variable depreciation: Makes profit forecasting more difficult than straight-line allocation.
- Complex maintenance interaction: Heavy use years may coincide with higher repair costs, affecting profit volatility.
8. Comparison with Other Depreciation Methods
| Depreciation Method | Basis of Calculation | Best Used For |
|---|---|---|
| Machine Hour Method | Usage (hours run) | Machinery and production equipment |
| Straight-Line Method | Equal annual charge | Buildings, office assets, steady-use equipment |
| Reducing Balance Method | Percentage of book value | Vehicles, technology assets, rapidly declining items |
This comparison highlights how the Machine Hour Method aligns depreciation with production intensity rather than time or value.
When to Use the Machine Hour Method
The Machine Hour Method is ideal when:
- Machine wear and tear depends directly on usage.
- Accurate job or product costing is essential.
- Production fluctuates monthly or seasonally.
- Management requires detailed cost allocation for performance and budgeting.
- Compliance with IAS 16 requires reflecting usage-based consumption.
It provides one of the most realistic and production-aligned approaches to depreciation in capital-intensive industries.
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