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Telford Co is considering the acquisition of a new machine costing $560,000 which has a useful economic life of five years.
Telford Co could take out an 7.5% bank loan, repayable over five years, to meet the cost of buying the new machine. Tax allowable maintenance costs will be incurred each year at $20,000 per year. Tax-allowable depreciation would be available on the new machine on a straight-line basis over five years. The machine would have a residual value of $60,000 at the end of five years.
Telford Co pays corporation tax of 20% one year in arrears.
Telford Co uses internal rate of return (IRR) to appraise investment projects and has an after-tax weighted average cost of capital of 9%.
What would you calculate the tax relief on tax allowable depreciation for the 5 years as ?
Since it says straight line method , I calculated it as :-
( COST – SCRAP )/ USEFUL LIFE ) * TAX = the amount would be the same for all 5 years as its a straight line method.
( (560,000-60,000) / 5 ) *20% TAX = 20,000
The thing is you have to calculate
560 / 5 = 112 * 20% = 22.4 for year 1-4 as tax in arrears it’s periods 2-5
Then in the 5th yr
The wdv = 112
RV = 60
So the bal allow is 52 * 20% = 10.4 for period 6so does this mean, that we’re supposed to calculate the balancing allowance whenever they tell us to find the tax relief on a ” straight line method ” and when they also mention that ” tax will be paid in arrears” ?
So I’m assuming we take the same value of tax relief ( on a striaght line method ) for all years when the question only mentions that tax is payable on the same day transaction occurs ( meaning not in advance nor in arrears , just the same day )
Pls lemme know <33
Correct
When the question specifies that tax will be paid in arrears, you should calculate the balancing allowance. The balancing allowance is the difference between the initial cost of the asset and the sale proceeds. It is used to determine the tax relief in the final year.
However, if the question mentions that tax is payable on the same day the transaction occurs, and the tax relief is based on a straight-line method, you would use the same value of tax relief for all years.
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