Question

Determine differences in taxes paid using SL and MACRS depreciation methods Equipment associated with manufacturing small railcars had a first cost of $230,000 with an expected salvage value of $30,000 at the end of its 5-year life. The revenue was $614,000 in year 2, with operating expenses of $98,000. If the company's effective tax rate was 31%, what would be the difference in taxes paid in year 2 if the depreciation method were straight line instead of Modified Accelerated Cost Recovery System (MACRS)? The MACRS depreciation rate for year 2 is 32%. The difference in taxes paid is determined to be $ 12000

Answer 1

The difference in taxes paid in year 2 between using the Straight Line (SL) depreciation method and the Modified Accelerated Cost Recovery System (MACRS) can be calculated by first finding the annual depreciation expense for both methods. By subtracting the taxes paid using the MACRS method from the taxes paid using the SL method, we can determine the difference in taxes paid. In this scenario, the difference in taxes paid in year 2 is $10,416.

Step-by-step explanation:

In this scenario, the question asks about the difference in taxes paid in year 2 if the depreciation method were straight line instead of the Modified Accelerated Cost Recovery System (MACRS). The MACRS depreciation rate for year 2 is 32%. To calculate the taxes paid using the straight-line (SL) method, we need to find the annual depreciation expense by subtracting the salvage value from the first cost and then dividing it by the asset's useful life. In year 2, the depreciation expense for SL would be:

Depreciation expense (SL) = (First cost - Salvage value) / Useful life = ($230,000 - $30,000) / 5 = $40,000.

The taxable income for year 2 would be the revenue minus the operating expenses and the depreciation expense (SL and MACRS). The taxes paid can then be calculated by multiplying the taxable income by the effective tax rate of 31%.

By comparing the taxes paid using the SL and MACRS depreciation methods, we can find the difference in taxes paid.

Let's calculate the taxes paid using MACRS first:

MACRS depreciation expense (Year 2) = Initial cost * MACRS depreciation rate (Year 2) = $230,000 * 32% = $73,600.

Taxable income (Year 2, MACRS) = Revenue - Operating expenses - MACRS depreciation expense = $614,000 - $98,000 - $73,600 = $442,400.

Taxes paid (Year 2, MACRS) = Taxable income (Year 2, MACRS) * Effective tax rate = $442,400 * 31% = $137,144.

Now let's calculate the taxes paid using SL:

Taxable income (Year 2, SL) = Revenue - Operating expenses - SL depreciation expense = $614,000 - $98,000 - $40,000 = $476,000.

Taxes paid (Year 2, SL) = Taxable income (Year 2, SL) * Effective tax rate = $476,000 * 31% = $147,560.

The difference in taxes paid between SL and MACRS in year 2 would be:

Difference in taxes paid = Taxes paid (Year 2, SL) - Taxes paid (Year 2, MACRS) = $147,560 - $137,144 = $10,416.