Curriculum Reading 26 Question 20 (help!) (regarding the calculation of amortization expenses using units-of-production metod)

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
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!

175,000 is used because that is the total number of products expected to be produced under the patent during its life. Just because there is plant capacity to produce more product does not mean that is the likely production scenario.

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A truck may last 250,000 miles over its entire life, but you might expect to use it only 50,000 miles per year.

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Thank you!

Thank you for your help!

My pleasure.

Hi. I agree with you guys, but then on exercise 15 "

Miguel Rodriguez of MARIO S.A., an Uruguayan corporation, is computing the depreciation
expense of a piece of manufacturing equipment for the fiscal year ended 31
December 2009. The equipment was acquired on 1 January 2009. Rodriguez gathers
the following information (currency in Uruguayan pesos, UYP):

Cost of the equipment UYP 1,200,000
Estimated residual value UYP 200,000
Expected useful life 8 years
Total productive capacity 800,000 units
Production in FY 2009 135,000 units
Expected production for the next 7 years 95,000 units each year

If MARIO uses the units- of- production method, the amount of depreciation
expense (in UYP) on MARIO’s income statement related to the manufacturing
equipment is closest to:

A 118,750.
B 168,750.
C 202,500.

Supposedly b) is correct as per book. However instead of using Expected production for the next 7 years (95,000*7 = 665,000) they are using “Total Productive Capacity” of 800,000.

Based on the previous answers, it seems that this is incorrect.

Could you please comment on this?

Thank you.

Using the total productive capacity is correct.

If you’re allowed to use your expected production, you can manipulate the depreciation.

Well it seems that in a CFA multiple choice test there is no grey area. So my reasoning doesn’t seem to be wrong when comparing to your previous answers, however it is for CFA. :confused: what to do?

The 8 year total capacity in your scenario = the current first year production + 7 remaining years expected production = 800,000 either way you look at it.

In the first example above, the 175,000 figure is also the “total” production capacity under the patent during its existence. It is not merely the total remaining or future production. It’s the total capacity, just like the 800,000 figure in your question is given as total capacity.

Perhaps I am missing something but I actually see no inconsistency between the 2 question answers and the explanations folks have provided above…? Seems like everyone is saying the same thing but CFA questions are playing around with wording only.

Cheers, good luck, you got this👍

This makes a lot of sense! I didn’t count the first year, but the 7 next. Tricky question! Thank you!

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