A firm purchases an asset with a cost of $30,000. The firm depreciates the asset

Question

A firm purchases an asset with a cost of $30,000. The firm depreciates the asset to zero oviial straight-line for book purposes and accelerated purposes data for this firm for the first three years ( ted for tax purposes. The current tax rate is 30%. Below is partial Tax Reporting Revenue Depreciation (accelerated) Taxable Income Year 3 20,000 5,000 . Year 1 20,000 12,000 Year 2 20,000 8,000 Year 3 20,000 FinancialReporting Year 1- 20,000 Year 2 20,000 Revenue Depreciation (Straight-Line) Pretax Income a. (2 points) Calculate the tax base of this asset at the end of year 1. b. (2 points) Calculate the carrying value of the asset at the end of year 1. c. (4 points) Calculate the deferred taxes on the balance sheet at the end of vear 1 and at the end of year 2 Also indicate whether they will be deferred tax assets or deferred tax liabilities. d. (4 points ) Use the information above but now assume that early in year 2, the tax rate unexpectedly rises to 50%. Calculate the firm's effective tax rate for year 2.

Explanation / Answer

a.

Tax base at the end of year 1= 18000

2.

carrying value at the end of year 1= 24000

c.

it is deferred tax liability because book depreciation is lower than tax depreciation which gives rise to more book income now than tax income. Because of this in future tax will be high.

d.

deferred tax expense for the year will be:

Current tax expense:

Total tax expense= 2200+6000= 8200

Book profit= 20000 - 6000( Book dep)= 14000

Effective tax rate= Total tax expense/ book profit= 8200/14000= 59%

Tax netbookvalue Accumulated depreciation Tax base Year Gross block Opening balance Depreciation Closing balance Net block 1              30,000                        -              12,000              12,000              18,000 2              30,000              12,000              8,000              20,000              10,000 3              30,000              20,000              5,000              25,000                 5,000

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