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chicago.cpa
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Joined: 05 Aug 2009
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Posted: 27 Aug 2009 at 23:24 \| IP Logged

When calculating the depreciation tax shield, how do you
compute the annual depreciation? Is it just the original
investment cost divided by the number of years? Or do you
also include the installation charges, shipping fees, and
etc.? Because I know that to find the cash outflow for the
first year, the extra charges are added to the cost of the
project... but I feel like some becker questions have this
whole sum used to calculate the yearly depreciation and
other questions just use the original cost of the project.

I hope my questions makes sense. Thanks for any help!

kj_nyc
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Joined: 05 Jun 2009
Location: United States
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Posts: 1145

Posted: 28 Aug 2009 at 08:51 \| IP Logged

You also include the installation charges, shipping fees, etc. because they are part of the depreciable basis; you include all costs associated with purchasing, installing, and placing the asset into service. Because you are ultimately trying to find the tax benefit from depreciation, you calculate tax depreciation, which might or might not be the same as depreciation on the financial statement, then multiply by the tax rate to get the tax benefit.

caixinran
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Joined: 10 Jun 2009
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Posts: 159

Posted: 28 Aug 2009 at 12:43 \| IP Logged

Thanks KJ-NYC, Great Explanation.

Some points I noted to myself:

1) Depreciation itself is not a cash outflow

2) Depreciation Tax Shield is a tax basis term, it is
different from GAAP term

3) Depreciable basis should including all the cost basis,
shipping testing and installation.

4) Depreciation tax shield is the (tax basis)
depreciation times the overall tax rate.

-------------- For example -----------------------

Company A purchased a new machine at the beginning of the
year.

a) Price for the machine will be $200,000 , Shipping
$4,000, and installation will cost $6,000

b) Machine will be fully depreciated within 7 years, and
will work for 15 years. assume no salvage value at the
end.

c) Overall tax rate will be 25%. What is the Depreciation
Tax Shield in year 2?

--------------------------------------------------------

Solution:

1) Find the depreciable basis = $200,000 + $4,000 +
$6,000 = $210,000

2) Find Year 2 depreciation

Depreciable terms = 7 years

year 2 Depreciation (tax purpose, single line) = $210,000
/ 7 = $30,000

3) Tax rate = 25%
Then the Depreciation Tax Shield = $30,000 x 25% = $7,500

------------------- Hope can help---------------------

Good luck to all of us!

__________________
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kj_nyc
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Joined: 05 Jun 2009
Location: United States
Online Status: Offline
Posts: 1145

Posted: 28 Aug 2009 at 13:26 \| IP Logged

caixinran, great notes and example, but I disagree with you on 1). The Depreciation Tax Shield is in effect an actual cash inflow because it saves you cash by reducing your tax liability, so you spend less cash paying for taxes.

caixinran
Regular
Regular

Joined: 10 Jun 2009
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Posts: 159

Posted: 28 Aug 2009 at 14:25 \| IP Logged

Thanks, kj_nyc

Basically, I just want to mention that the Depreciation
itself is not a cash outflow. The reducation/saving of the
tax will be a cash inflow.

Thanks again.

__________________
REG - July 21, 2009 - 94
BEC - Nov. 03, 2009 - 90
FAR - Aug. 07, 2010 - 96
AUD - Nov, 23, 2010 - 87

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