Comparing Depreciation Methods
Calculate depreciation using straight-line, double-declining balance, and units of production methods. Compare the impact on financial statements across methods.
Problem Scenario
On January 1, Year 1, Manufacturing Co. purchased equipment for $120,000. The equipment has an estimated useful life of 5 years or 100,000 units of production. Salvage value is estimated at $20,000. In Year 1, the equipment produced 25,000 units.
Given Data
Requirements
- Calculate Year 1 depreciation using straight-line method
- Calculate Year 1 depreciation using double-declining balance
- Calculate Year 1 depreciation using units of production
- Calculate book value at end of Year 1 under each method
Solution
Step 1:
Straight-Line Method: Depreciation = (Cost - Salvage) / Useful Life = ($120,000 - $20,000) / 5 years = $20,000 per year
Step 2:
Double-Declining Balance: Rate = 2 / 5 years = 40%. Year 1 Depreciation = $120,000 × 40% = $48,000. Note: Salvage value is not subtracted initially but limits total depreciation.
Step 3:
Units of Production: Depreciation Rate = ($120,000 - $20,000) / 100,000 units = $1.00 per unit. Year 1 Depreciation = 25,000 units × $1.00 = $25,000
Step 4:
Book Values at End of Year 1: Straight-Line: $120,000 - $20,000 = $100,000. DDB: $120,000 - $48,000 = $72,000. Units of Production: $120,000 - $25,000 = $95,000
Final Answer
Depreciation Expense: Straight-Line = $20,000, DDB = $48,000, Units of Production = $25,000. DDB results in highest expense in early years (accelerated method).
Key Takeaways
- ✓Straight-line produces equal depreciation each period
- ✓DDB is an accelerated method - higher expense early, lower later
- ✓Units of production matches expense to actual usage
- ✓All methods result in same total depreciation over asset life
Common Errors to Avoid
- ✗Subtracting salvage value when calculating DDB rate or first-year depreciation
- ✗Forgetting that DDB cannot depreciate below salvage value
- ✗Using useful life in years for units of production instead of total units
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Common questions about this problem type
Companies often switch from DDB to straight-line when straight-line depreciation exceeds DDB. This ensures the asset is fully depreciated (to salvage value) by the end of its useful life.
Accelerated methods like DDB are often preferred for taxes because they defer tax payments by recognizing more expense early. However, tax rules may require specific methods (like MACRS in the US).