A company purchases a stamping machine for $220,000 with an estimated salvage value of $20,000. Management estimates the machine will produce 400,000 units over its useful life. During its first year of use, the machine produces 50,000 units. Under the units-of-production depreciation method, what depreciation expense should be recognized for the first year?
- $25,000, computed by dividing the $200,000 depreciable base (cost less salvage value) by the 400,000 total estimated units to get a $0.50 per-unit rate, then multiplying by the 50,000 units actually produced in the first year
- $27,500, computed by dividing the full $220,000 cost, without deducting salvage value, by the 400,000 total estimated units, then multiplying by the 50,000 units produced
- $55,000, computed by dividing the $220,000 cost by the machine's estimated useful life in years rather than by total estimated units, then applying that annual amount to the units produced
- $20,000, the estimated salvage value, recognized as depreciation expense in the first year because the units-of-production method front-loads expense recognition relative to the straight-line method
Why A? And why not the others?
Correct answer: A. $25,000, computed by dividing the $200,000 depreciable base (cost less salvage value) by the 400,000 total estimated units to get a $0.50 per-unit rate, then multiplying by the 50,000 units actually produced in the first year
The units-of-production method allocates an asset's depreciable base — cost minus estimated salvage value — over its total estimated units of output, producing a constant per-unit depreciation rate that is then applied to actual output each period. Here the depreciable base is $220,000 minus $20,000, or $200,000, divided by 400,000 total estimated units, giving a rate of $0.50 per unit; applying that rate to the 50,000 units produced in the first year gives $25,000 of depreciation expense. Using the full $220,000 cost without subtracting salvage value overstates the depreciable base and ignores that GAAP depreciation methods systematically exclude the amount expected to be recovered at disposal. Dividing cost by useful life in years mixes up the units-of-production method, which is driven by output, with the straight-line method, which is driven by the passage of time, producing a nonsensical annual figure applied against unit output. Treating the $20,000 salvage value itself as the depreciation expense misunderstands what salvage value represents: it is the estimated residual amount excluded from depreciation, not an expense to be recognized, and the units-of-production method does not front-load expense the way a declining-balance method does.
Source: FASB ASC 360-10-35-4 (depreciation methods should be systematic and rational, including units-of-production, applied over the depreciable base net of estimated salvage value)