Chapter 7: Decpreciation and Income Taxes

Transcription

1 Chapter 7: Decpreciation and Income Taxes Tsui-Ping Chung 1

2 The goal The objective of Chapter 7 is to explain how depreciation affects income taxes, and how income taxes affect economic decision making. 2

3 Depreciation is the decrease in value of physical properties with the passage of time.( 时间流逝 ) It is an accounting concept, a non-cash cost, that establishes an annual deduction against before tax income. It is intended to approximate the yearly fraction of an asset s value used in the production of income. 3

4 Property( 不动产 ) is depreciable if it is used in business or held to produce income. it has a determinable useful life, longer than one year. it is something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes. it is not inventory, stock in trade, or investment property. 4

5 Depreciable property is tangible (can be seen or touched; personal or real) or intangible (such as copyrights, patents, or franchises). depreciated, d according to a depreciation schedule, when it is put in service (when it is ready and available for its specific use). 5

6 Definition Adjusted (cost) basis Basis or cost basis Book value(bv) Market value(mv) Recovery period Recovery rate Slavage value(sv) Useful life 6

7 Straight line (SL): constant amount of depreciation each year over the depreciable life of the asset. N = depreciable life B = cost basis d k = depreciaton in k BV k = book value at end of k SV N = salvage value N 7

8 Example 7.1 Cost basis of $200, and five year depreciable life. SV=$20,000 at the end of five years Ui Using SL method Annual depreciation amounts and the book value of laser at the end of yeat. 8 N = depreciable life B = cost basis d k = depreciaton in k k BV k = book value at end of k SV N = salvage value

9 Declining-balance (DB) A constant-percentage of the remaining BV is depreciated each year. B = cost basis d k = depreciaton in k BV k = book value at end of k k The constant percentage is determined by R, where R = 2/N when 200% declining balance is being used, R = 1.5/N when 150% declining balance is being used. 9

10 Example 7.2 Cost basis of $4,000 and 10 year depreciable life. SV=$0 at the end of 10 years Ui Using DB method R=2/N (200% DB method) R=1.5/N (150% DB method) 10

11 DB with switchover to SL DB never reaches a BV of zero, and it is permissible ibl to switch from this method to the SL method. This method is used in calculating the MACRS. 11

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13 The units-of-production method method can be used when the decrease in value of the assset is mostly a function of use, instead of time. The cost basis is allocated equally over the number of units produced d over the asset s life. The depreciation per unit of production is found from the formula below. Depreciation per unit of production: 13

14 Example 7.3 Cost basis of $50, and 30, hours of use. SV=$10,000 at the end of 30,000 hours Find its depreciation rate per hour of use and find its BV after 10,000 hours of operation. 14

15 Modified Accelerated Cost Recovery System is the principle method for computing depreciation for property in engineering i projects. It consists of two systems, the main system called the General Depreciation System (GDS) the Alternative Depreciation System (ADS). 15

16 When an asset is depreciated using MACRS( 加速资本回收系统 ), the following information is needed to calculate deductions. Cost basis, B Date the property was placed into service The property p class and recovery yperiod The MACRS depreciation method (GDS or ADS). The time convention that applies (half year) 16

17 Property class and recovery period Two types recovery periods ADS For tangible personal property, the ADS recovery rate is almost the same as the class life Under a 12 year ADS recovery rate GDS Most tangible personal property is assigned six classes.(3, 5, 7, 10, 15, 20) real property is assigned two real property classes: nonresidential and residential 39 years for nonresidential and 27.5 years for residential 17

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20 Depreciation methods, time convention and recovery rates GDS, 3, 5, 7, 10 year personal classes: The 200% DB method; then switching to SL GDS, 15, 20 year personal classes: The 1500% DB method; then switching to SL GDS nonresidential and residential: SL over the fixed GDS recovery period. ADS: SL method for both personal and real property over the fixed ADS recovery periods. 20 A half year tome convention: begin at middle of the year

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23 Using MACRS(GDS) is easy! Determine the asset s s recovery period (Table 7-2). Use the appropriate column from Table 7-3 that matches the recovery period to find the recovery rate, r k, and compute the depreciation for each year as 23

24 Example 7.4 A new piece of semiconductor manufacturing equipment. The cost basis for the equipment is $100,000. Determine The depreciation charge permissible in the fourth year, The BV at the end of the fourth year, The cumulative depreciation through the third year The BV at the end of the fifth year if the equipment is disposed of at that time? 24

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26 Example 7.5 Computer and peripheral equipment, used in business. BV at that time is $25,000. A new fast computer system have a MV $400, A deal was agreed to pay $325,000 What is the GDS property class of the new computer system? How much depreciation can be conducted each year based on this class life? 26

27 Example 7.6 Produced a large manufacturing of sheet metal products and placed in new computer-controlled flexible manufacturing system for $3.0 million Using ADS What depreciations can be claimed for the system? 27

28 A comprehensive depreciation example 7.7 Figure 7-2 BV Comparisons for Selected Methods of Depreciation in Example 7-7 (Note: The bus is assumed to be sold in year six for the MACRS-GDS method.) 28

29 There are many different types of taxes. Income taxes are assessed as a function of gross revenues minus allowable expenses. Property taxes are assessed as a function of the value of property owned. Sales taxes are assessed on the basis of purchase of goods or services. Excise taxes are federal taxes assessed as a function of the sale of certain goods or services often considered nonnecessities. 29

30 Taking taxes into account changes our expectations of returns on projects, so our MARR (after-tax) is lower. 30

31 The after-tax tax MARR should be at least the tax-adjusted weighted average cost of capital (WACC). 31 λ = fraction of a firm s pool of capital borrowed from lenders t = effective income tax rate as a decimal i b = before-tax interest paid on borrowed capital e a = after-tax tax cost of equity capital

32 Depreciation is not a cash flow, but it affects a corporation s taxable income, and therefore the taxes a corporation pays. Taxable income = gross income all expenses except capital invest. depreciation deductions. 32

33 Federal taxes are calculated cu ated using a set of income brackets. each applying a different tax rate on the marginal value of income. State t taxes vary widely. Tax rates are found in Table 7-5. Corporations need to know their effective tax rate,, which is a combination of federal and state taxes according to either formula below. 33

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35 Example 7.9 Gross income: $5,270,000, 000 expenses: $2,927,500 Depreciation deductions: $1,874,300 What would be its taxable income and federal income tax for the tax year? 35

36 The disposal of a depreciable asset can result in a gain or loss based on the sale price (market value) and the current book value A gain is often referred to as depreciation recapture( 折旧回朔 ), and it is generally taxed as the same as ordinary income( 正常收入 ). A loss is a capital loss. An asset sold for more than it s cost basis results in a capital gain. Example

37 General procedure for making after-tax economic analysis After-tax economic analysis is generally the same as beforetax analysis, just using after-tax tax cash flows (ATCF) instead of before-tax cash flows (BTCF). The analysis a s is conducted using the after-tax ta MARR. 37

38 Cash flows are typically y determined for each year using the notation below. R k = revenues (and savings) from the project during period k E k = cash outflows during k for deductible expenses d k = sum of all noncash, or book, costs during k, such as depreciation t = effective income tax rate on ordinary income T k = income tax consequence during year k ATCF k = ATCF from the project during year k 38

39 Some important cash flow formulas. Taxable income Ordinary income tax consequences 39

40 Figure 7-4 General Format (Worksheet) for After-Tax Analysis; Determining the ATCF 40

41 Example 7-12 and 13 41

42 Figure 7-5 Spreadsheet Solution, Example

43 Economic value added (EVA) is an estimate of the profit-earning potential ti 潜在性 of proposed capital investments in engineering projects. It is the difference between a company s adjusted net operating profit after taxes (NOPAT) in a particular year its after-tax cost of capital during that year. 43

44 where, and 44