Difference between Tax allowable depreciation and capital allowance

Firstly, because of the title you gave this post, ‘tax allowable depreciation’ and ‘capital allowances’ both mean exactly the same thing.
You are always told the method (usually it is reducing balance, but sometimes it is straight line).

With regard to how to deal with them, there are two approaches – both of which will give the same final answer.

On way is to subtract the allowances to get the taxable profit, then calculate the tax, then add back the allowances because they are not themselves a cash flow.

The other way (and usually much the better, quicker, and safer way) is to calculate the tax on the cash flows (without subtracting allowances) and then separately calculate the tax that will be saved because of the allowances.

This second way is the way I do it in my lectures and it much the better way. Not only do I think it is easier, but (just as important) if something does go wrong in one of the calculations then you still get marks for other calculations that were correct. If you use the first way it is much harder for the marker if you have made just one mistake somewhere because one mistake makes lots of figures wrong.

However, both approaches will end up giving the same final answer.

You are welcome 🙂

Dear John, Please can you help me calculate the Tax allowable depreciation on this question on a straight line basis.? Many thanks

Parrott Co is a UK based company. It is considering a 3 year project in
Farland.
The project will require an initial investment of 81m Farland Florins (FFl)
and will have a residual value of 10m FFl.
The project’s pre tax net FFl inflows are expected to be:
The UK parent company will charge the overseas project with £2m of
management charges each year.
Year 1 35m
Year 2 80m
Year 3 50m
The current spot rate is 5FFl – £1. UK inflation is expected to be 4% per
annum, and Farland inflation is expected to be 7% per annum.
Farland tax is 20% and is paid immediately. Any losses are carried
forward and netted off the first available profits for tax purposes. Tax
allowable depreciation will be granted on a straight line basis, and any
residual value will be taxable at 20%. UK tax is 30% and is payable 1
year in arrears.
Parrott Co recently undertook a similar risk project in the UK and used
11% as a suitable discount rate.
Required:
Calculate the NPV of the project in £.

Hi! I have a question on the case described above. It is written that an investment is 81m and residual value is 10m. Why is tax allowable depreciation charged on a straight-line basis is calculated without taking the residual value into account?
According to solution to this question, annual TAD is 81/3=27
However, I expected it to be (81-10)/3=23,67
Thank you in advance

Good Day, I was doing Blades Plc question, and worked the tax separately then minus it from profits, but i got different answer from the suggested answer, can you please guide me of where i went wrong. also if Capital Alowances is greater than profit will this create a loss c/f?
this is info for tax part of the question and my taxation working:

cost of machinery 450,000, The project is expected toproduce net annual operating cash flows of $220,000 for each of thethree years of its life. At the end of this time its scrap value will bezero. Corporation tax is at a rate of 30%, payable in the same year. Themachine will attract a 70% initial capital allowance and the balance isto be written off evenly over the remainder of the asset life and isallowable against tax. The firm is certain that it will earn sufficientprofits against which to offset these allowances.

W1 – Taxation
Years  0 1 2 3

Operating Cash flows 220,000 220,000 220,000
TAD W1b -315,000 -67,500 -67,500
Adjusted Cash flows 0 -95,000 152,500 152,500
Offset any profit against
 prev losses -95,000
loss c/f

taxable profit 57,500 152,500
tax @30% 17,250 45,750
year paid-same yr2 yr3

please guide me to where i went wrong, the suggested answer uses another method but i didnt learn that one and both answers different.

Thanking you in advance.

my answer:
Blades Plc

Years  0 1 2 3

Operating Cash flows 220,000 220,000 220,000
Less Taxation- w1 -17250 -45750
Investment -450,000
Cash Flows -450,000 220,000 202,750 174,250
Base Case Discount Rate @16 % -w2 1 0.862 0.743 0.641
Present Values -450,000 189,640 150,643 111,694
Base Case NPV 1,977

suggeste answer:
Blades Plc

Years  0 1 2 3
Equipment -450,000
capital allowances 94,500 20,250 20,250
Operating Cash flows 220,000 220,000 220,000
Less Taxationon op cf -66000 -66000 -66000

Cash Flows -450,000 248,500 174,250 174,250
Base Case Discount Rate 1 0.862 0.743 0.641
 @16 % -w2

Present Values -450,000 214,210 129470 111,694
Base Case NPV 5374

please can you confirm if capital allowances is higher than profits, does it lead to loss c/f. thank you

thank you so much sir, i got the same answer now, so please tell me if i understood this correctly…. this means if cap allowances greater than profits, we get tax saving of the difference? and for all questions except international invest. we do this. and make this assumption?

also sir, can you suggest any question with this similar situation i can practice this concept plz. i did quite a bit of investment questions, but so far blades and tippletine had a loss. however tippletine co. loss was from from operating profit, but also TAD increased the loss BUT in this case the loss was cf….