Question

Management's choice of depreciation methods will usually create a difference between financial reporting income (net income in the financial statements) and taxable income (for IRS purposes)

True or False? (and why?)

Answer 1

Solution: True

Explanation: Majority of the companies use different methods of depreciation for financial and tax reporting. It is because the companies usually make different accounting choices in tax reporting and financial reporting as there are different incentives which need to be put in place. It is evident that the profitable companies often want to minimize their income taxes and therefore the financial managers usually make accounting choices that results in lowering the net income generated thus leading to minimizing of taxes. One of the accounting choices that management makes lead to lowering the taxable income includes accelerated depreciation method instead of the straight line method. The firm applies the straight line method for their financial statements and accelerated method for income taxation computations. The accelerated depreciation method leads to the pre-tax income, income tax expense, net income, and profit margins to be not higher in the initial phase, however higher in the later life of the asset, in comparison of the straight-line depreciation method. But the values of taxes, depreciation, pre-tax income, net income and profit margin would remain unaffected by the method selected for depreciation