Question

List three reasons for using a different depreciation method for financial purposes and for tax purposes?

Answer 1

Financial depreciation is the amount recorded in the company's general ledger accounts and reported on the company's financial statements. This depreciation is based on the matching principle of accounting.

Tax depreciation refers to the amounts reported on the company's income tax returns and in the U.S. the tax depreciation is based on the regulations of the Internal Revenue Service (IRS). The tax regulations specify the useful life of assets but also allow for accelerated depreciation or the immediate expensing of certain amounts on some companies' tax returns.

The difference between book depreciation and tax depreciation involves the "timing" of when the cost of an asset will appear as depreciation expense on a company's financial statements versus the depreciation expense on the company's income tax return.

The depreciation method commonly used for financial purposes is the straight-line method and the one used for tax purposes is accelerated depreciation method. The biggest benefit of the accelerated depreciation method is the tax benefit. By writing off more assets against revenue, companies report lower income and thus pay less tax.

If the straight-line method was used, the depreciation would be constant and the maintenance cost would increase which would increase the total expenses.

Accelerated depreciation will offset the increasing maintenance cost and essentially equalizes the combined charges of both maintenance and depreciation.