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Dear all,
In chapter 9, BPP F9,
A company is considering whether or not to purchase an item of machinery costing $40,000 payable
immediately. It would have a life of four years, after which it would be sold for $5,000. The machinery
would create annual cost savings of $14,000.
The company pays tax one year in arrears at an annual rate of 30% and can claim tax-allowable
depreciation on a 25% reducing balance basis. A balancing allowance is claimed in the final year of
operation. The company’s cost of capital is 8%.Year Tax-allowable depreciation
1 40,000 × 0.25 = 10,000
2 10,000 × 0.75 = 7,500
3 7,500 × 0.75 = 5,625
23,125
4 40,000 – 5,000- 23,125= 11,875I am wodering why they dont calculate Tax-allowable depreciation by deducting residual value of $ 5,000 in the 1st, 2nd, 3rd year?
1 (40,000 -5,000)x0.25 = 8750
2 (40,000 -5,000 -8750)x0.25 =…
3…
4…
Thank you.
Tax allowable depreciation is not the same as financial accounting depreciation, and is always calculated based on the original cost. When the asset is sold, there is then a balancing charge or allowance of the difference between the sale proceeds and the tax written down value.
(If the tax authorities were to allow the depreciation to be based on cost less estimated sale proceeds, then companies would be deliberately choosing different estimated sale proceeds in order to change the tax liability!!)
All of this is explained in detail in my free lectures on investment appraisal with tax. The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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