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Anybody who can please answer me that why we need to calculate for 5 years? The asset only has 4 year life.
And why we calculate tax saving on depreciation from year1 not year2.
Many thanks in advance.
Which mock exam are you asking about? Question 3 of our mock exam does not involve a project.
However…..without knowing which question you are talking about, I would guess that the reason we need time 5 is because of tax being payable one year in arrears.
As regards the tax savings on depreciation, we assume the asset it bought on the first day of the year (time 0) and so the tax is calculated at the end of the year (time 1). If there is a one year delay in tax, then the tax effect will be one year later (time 2).
0, 1, 2 etc are not years – they are points in time. Time 1 is one year later than time 0, time time is 2 years later, and so on. The only reason that we need the timing is because of discounting. We are not worried about 1 or 2 days, and so the beginning of the first year is time 0 and the end of the first year is time 1 – it is one year later and so needs discounting for one year.
(If you have not already watched it, then I really do suggest that you watch our lecture on relevant cash flows and dealing with tax and inflation.)
Thanks a lot John for quick reply.
I’m asking Q3 of Mock1 in BPP PRACTICE & REVISION KIT.
I understand what you said. But in this question. WDA Tax saving is considered in year1. But why not in year2.
I do not have the latest BPP Revision Kit. However, the one that I have seems as though it may have the same question – part (b) starts “Howgill Co…”
If is is not that question then I am afraid that I cannot help you – I do not keep books from every publisher.
However, with regard to Howgill, it is because the question says that we buy the machine on the last day of the current financial year. Capital allowances are first calculated in the financial year in which the machine is purchased. As a result, even though we both the machine on the last day, a full 25% capital allowance will be calculated immediately. Tax is payable one year later and so the tax saving will be one year later at time 1.
As to why we get capital allowances for 5 years, it is because we get them in the year we buy the machine and then for each of the 4 years that we actually use it (although as usual, the calculate for the 5th allowance is not 25% but is the balancing allowance or balancing charge).
This problem with the tax saving is only likely ever to occur in a lease or buy question. If you are still not clear, then my lecture on lease and buy does explain the problem.
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