Delta Machine Company purchased a computerized assembly machine for $135,000 on January 1, 2018. Delta Machine Company estimated that the machine would have a life of four years and a $25,000 salvage value. Delta Machine Company uses the straight-line method to compute depreciation expense. At the beginning of year 3 (2020) Delta discovered that the machine was quickly becoming obsolete and would have little value at the end of its useful life. Consequently, Delta Machine Company revised the estimated salvage to only $5,000. It did not change the estimated useful life of the machine. Compute the depreciation expense for each of the four years.

Depreciation expense:

Year 1 = $27,500

Year 2 = $27,500

Year 3 = $37,500

Year 4 = $37,500

Explanation:

Annual depreciation is computed using the equation given below:

Annual depreciation = {Cost of machine - Salvage value} ÷ Estimated life

= {$135,000 - $25,000} ÷ 4

= $27,500

Depreciation of year 1 is $27,500

Cost of machine in year 2 is {$135,000 - $27,500} = $107,500

Depreciation of year 2 is $27,500

Cost of machine in year 3 is {$107,500 - $27,500}  = $80,000

Annual depreciation is computed using the equation given below:

Annual depreciation = {Cost of machine - Salvage value} ÷ Remaining estimated life

= {$80,000 - $5,000} ÷ 2

 = $37,500

Depreciation expense of year 3 is $37,500

Cost of machine in year 4 is ($80,000 - $37,500) = $42,500

Depreciation expense of year 4 is $37,500

Cost of machine at the end of year 4 is ($42,500 - $37,500) = $5,000

Year          Depreciation

  1                   $27,500

  2                  $27,500

  3                  $37,500

  4                  $37,500

Explanation:

The cost of Property, plant, and equipment is charged to P&L evenly under straight-line depreciation method. The depreciation under this method is calculated as:

     Annual Depreciation Expense = (Cost - Salvage Value) / Useful Life

⇒ The annual depreciation is $27,500 [(135,000 - 25,000) / 4].

This amount will be charged as depreciation expenses in P&L statements each year for the life of asset because the cost is allocated evenly under straight-line method. But at the beginning of 3rd year, the management has decided to revise the salvage value. It is a change of accounting estimate and not error, so the depreciation expense of two years that is already recorded will not be changed. However, the depreciation of the remaining two years should be revised. The formula to it is:

                Revised Depreciation = (BV - RSV) / Remaining Useful Life

where

BV = Book value = Cost - Accumulated depreciation

                            = 135,000 - (27,500 * 2) = $80,000

RSV = Revised Salvage Value = $5,000

⇒ Depreciation expense that is to charged to P&L each year for the last two remaining years is $37,500 [(80,000 - 5,000) / 2].

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