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Hello John,
S Co has a 31 Dec year end and pays corporation tax at a rate of 30%, 12 months after the end of the year to which the cash flows relate. It can claim tax allowable depreciation at a rate of 25% reducing balance. It pays $1m for a machine on 31 December 20×4. SW CO’s cost of capital is 10%.
What is the present value on 31 Dec 20×4 of the benefit of the first proportion of the tax allowable depreciation?
1. The answer is $68,175
2. In the answer, it says that ” the asset is purchased on 31 Dec 20×4(T0) so the first proportion of the tax allowable depreciation is accounted on that date( as this is the end of the year)3. My issue is that how can we claim depreciation as 31 Dec 20×4 as this is the date of purchase and depreciation should start as from 1 Jan 20×5 and this should be the first year of depreciation.
4. Please advise where I am getting things wrong.
Thanks
Tax allowable depreciation (capital allowances) is not the same as financial accounting depreciation. It is calculated at the end of the financial year in which the asset is purchased (regardless of when in the year, even if it is purchased on the last day of the year).
Therefore the first allowance is calculated on 31 December 20X4 and the tax saving is made one year later because there is a 12 month delay in paying tax.
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