A contractor purchases equipment for $120,000 with a 5-year useful life and $20,000 salvage value. Using straight-line depreciation, what is the annual depreciation expense?
Correct Answer
A) $20,000
Straight-line depreciation = (Cost - Salvage Value) ÷ Useful Life. ($120,000 - $20,000) ÷ 5 years = $20,000 per year.
Why This Is the Correct Answer
Option A is correct because straight-line depreciation calculates the annual expense by taking the depreciable amount (cost minus salvage value) and dividing it evenly over the useful life. The equipment costs $120,000 but will retain $20,000 in value at the end, so only $100,000 needs to be depreciated. Dividing this $100,000 over 5 years gives us $20,000 per year in depreciation expense.
Why the Other Options Are Wrong
Option B: $24,000
This answer ($40,000) incorrectly divides the depreciable amount by 2.5 years instead of 5 years, or may represent confusion with accelerated depreciation methods.
Option C: $30,000
This answer ($24,000) incorrectly divides the full purchase price by the useful life ($120,000 ÷ 5 = $24,000) without subtracting the salvage value first.
Option D: $40,000
This answer ($30,000) appears to be calculated by dividing the depreciable amount by 3.33 years instead of 5 years, or possibly confusing this with a different depreciation scenario.
Memory Technique
Remember 'CSS' - Cost minus Salvage, then Spread over years. The salvage value is what you 'salvage' at the end, so don't depreciate it!
Reference Hint
Look up 'Depreciation Methods' or 'Straight-Line Depreciation' in the accounting/financial management chapter of your contractor reference manual
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