Question

Equipment associated with manufacturing small railcars had a first cost of $180,000 with an expected salvage value of $30,000 at the end of its 5-year life. The revenue was $630,000 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 $ _______.

Answer 1

The difference in taxes paid between straight line and MACRS depreciation methods for the equipment in year 2 is $8,556, with MACRS offering greater tax savings due to higher depreciation.

Step-by-step explanation:

The question is centered around the computation of tax differences resulting from the usage of two different methods of depreciation on equipment: straight line and the Modified Accelerated Cost Recovery System (MACRS). To calculate the difference in taxes paid due to the two depreciation methods, we should first establish the annual depreciation expense for each method. For the straight line method, the depreciation expense would be calculated by subtracting the salvage value from the first cost and then dividing by the life of the asset. The MACRS depreciation rate given for year 2 is 32%.

For straight line depreciation, the depreciation for each year would be: (First Cost - Salvage Value) / Useful Life = ($180,000 - $30,000) / 5 = $30,000.

For MACRS depreciation in year 2, it would be First Cost * MACRS Depreciation Rate = $180,000 * 32% = $57,600.

The difference in depreciation is $57,600 - $30,000 = $27,600. The tax saving due to depreciation is this difference multiplied by the tax rate, which is 31% in this case. So the tax savings difference is $27,600 * 31% = $8,556.

Therefore, the company would pay $8,556 less in taxes in year 2 if it used MACRS depreciation compared to straight line depreciation.