20 A financial analyst is analyzing the amortization of a product patent acquired by MAKETTI S.p.A., an Italian corporation. He gathers the following information about the patent:
Acquisition cost | €5,800,000 |
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Acquisition date | 1 January 2009 |
Patent expiration date | 31 December 2015 |
Total plant capacity of patented product | 40,000 units per year |
Production of patented product in fiscal year ended 31 December 2009 | 20,000 units |
Expected production of patented product during life of the patent | 175,000 units |
If the analyst uses the units-of-production method, the amortization expense on the patent for fiscal year 2009 is closest to:
A €414,286. B €662,857. C €828,571.
The answer to this practice problem in the curriculum is B. The explanation in the curriculum is as follows:
B is correct. Using the units-of-production method, depreciation expense amounts to
Depreciation expense = 5,800,000 × (20,000/175,000) = 662,857
When I did this practice problem, I calculated the amortization expense in this way:
amortization expense = acquisition cost * Production of patented product in 2009 / (Total plant capacity of patented product per year * patent life) = €5,800,000 × 20,000 units/ (40,000 units per year * 7 years) = €414,286
The definition of the units-of-production method in the curriculum is:
In the units-of-production method, the amount of depreciation expense for a period is based on the proportion of the asset’s production during the period compared with the total estimated productive capacity of the asset over its useful life.
But I still cannot understand: (1)Why 175,000 is in the denominator? (2) What is the difference between “Total plant capacity of patented product” and “Expected production of patented product during life of the patent”?
Could anyone do me a favor? Thanks so much!