Tuttle Construction Co. specializes in building replicas of historic houses. Tim
ID: 2482403 • Letter: T
Question
Tuttle Construction Co. specializes in building replicas of historic houses. Tim Newman, president of Tuttle Construction, is considering the purchase of various items of equip- ment on July 1, 2014, for $400,000. The equipment would have a useful life of five years and no residual value. In the past, all equipment has been leased. For tax purposes, Tim is considering depreciating the equipment by the straight-line method. He discussed the matter with his CPA and learned that, although the straight-line method could be elected, it was to his advantage to use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. He asked for your advice as to which method to use for tax purposes.
1. Compute depreciation for each of the years (2014, 2015, 2016, 2017, 2018, and 2019) of useful life by (a) the straight-line method and (b) MACRS. In using the straight-line method, one-half year’s depreciation should be computed for 2014 and 2019. Use the MACRS rates presented in Exhibit 9.
2. Assuming that income before depreciation and income tax is estimated to be $750,000 uniformly per year and that the income tax rate is 40%, compute the net income for each of the years 2014, 2015, 2016, 2017, 2018, and 2019 if (a) the straight-line method is used and (b) MACRS is used.
Explanation / Answer
1) Depreciation under Straight line method Year Depreciation $ Calculation Using Formula 2014 40,000 $400,000 × 1/1.5 × 0.5 2015 80,000 $400,000 × 1/1.5 2016 80,000 $400,000 × 1/1.5 2017 80,000 $400,000 × 1/1.5 2018 80,000 $400,000 × 1/1.5 2019 40,000 $400,000 × 1/1.5 × 0.5 Depreciation under MACRS Year Depreciation $ Calculation Using Formula Calculation Using Table 2014 80,000 $400,000 × 1/5 × 200% × 0.5 $400,000 × 20% 2015 1,28,000 ($400,000-$80,000) × 1/5 × 200% $400,000 × 32% 2016 76,800 ($400,000-$80,000-$128,000) × 1/5 × 200% $400,000 × 19.2% 2017 46,080 ($400,000-$80,000-$128,000-$76,800) × 1/5 × 200% $400,000 × 11.52% 2018 46,080 Note A $400,000 × 11.52% 2019 23,040 Note B $400,000 × 5.76% Note A: MACRS declining balance changes to straight-line method when that method provides an equal or greater deduction. Deduction under 200% declining balance MACRS for 2018 would be $27,648 ($400,000 - $80,000 - $128,000 - $76,380 - $46.080) × 1/5 × 200%. This is lower than depreciation under straight line method over the remaining recovery period which comes out to be $46,080 (=$400,000 - $80,000 - $128,000 - $76,380 - $46.080) × 1/1.5). Note B: Due to half-year convention, depreciation charged for half-year in 2019 2) Year Income before depreciation & Tax Depreciation Under straight line $ Profit Before Tax $ Tax @ 40% $ Depreciation Under MACRS $ Profit Before Tax $ Tax @ 40% $ 2014 7,50,000 40,000 7,10,000 2,84,000 80,000 2,04,000 81,600 2015 7,50,000 80,000 6,70,000 2,68,000 1,28,000 1,40,000 56,000 2016 7,50,000 80,000 6,70,000 2,68,000 76,800 1,91,200 76,480 2017 7,50,000 80,000 6,70,000 2,68,000 46,080 2,21,920 88,768 2018 7,50,000 80,000 6,70,000 2,68,000 46,080 2,21,920 88,768 2019 7,50,000 40,000 7,10,000 2,84,000 23,040 2,60,960 1,04,384 3) Factors to be considered while selecting depreciation method i) Value of the assets ii) Usefull life of the assets iii) Nature of the assets
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