Your firm uses a straight-line depreciation method for all its equipment in its

Question

Your firm uses a straight-line depreciation method for all its equipment in its financial reports. The firm recently bought a piece of machinery with the characteristics given below. What amount will your firm record as a deferred tax asset or liability after the first year of this machinery's use?

Deferred tax liability of $64,000

Deferred tax liability of $160,000

Deferred tax asset of $64,000

Deferred tax asset of $160,000

Useful life of machinery in years 4 Total acquisition cost $800,000 Your firm's marginal tax rate 40% Depreciation rates allowed by IRS: year 1 2 3 4 depreciation rate 45% 33% 15% 7%

Explanation / Answer

Accounting Depreciation = $800,000/4 = $200,000

Income Tax Depreceation (As per IRS rates) = $800,000 x 45% = $360,000

Difference in depreciated amount = $360,000 - $200,000 = $160,000

As accounting depreciation is less than the IT depreciation, it will create a deferred tax asset, which can be claimed in coming years.

So, Deferred tax asset = $160,000 x 40% = $64,000    (As tax rate is 40%)

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