Question

Company A depreciates its main assets over 10 years on a straight-line basis, with an estimated residual value of 10 percent of initial cost. Company A’s main competitor Company B estimates its depreciation of the similar assets using the straight-line method but assuming an average annual depreciation of 5.0 percent. No operating differences appear to be existing between these companies. Company A’s marginal tax rate is 20 percent, reported asset cost 1/1/2019 is 140,000, and accumulated depreciation 1/1/2019 is 88,200. An analyst is thinking of making the performance of these companies more comparable by adjusting the financial statements of Company A. How much would Net Profit increase in Company A in 2019, if the analyst were to make an accounting adjustment so that Company A also uses the same depreciation rate as Company B?

Answer 1

Company A Total Useful Life Depreciation Method Reported Assets Cost Accumulated Depreciation Company B Useful Life Depreciation Method 10 years 5.00% 10 Years Straight line 140000 88200 Depreciation as per Straight Line Method Yearly Depreciation (140000-(10%*140000)/10 12600 Machine life utilised till 1/1/2019 Accumulated Depreciation / Yearly Depreciation Remaining Useful life Total Useful Life - Machine life utilised till 1/1/2019 Depreciating Assets based on Depreciation method of Company B till 1/1/2019 Yearly Depreciation would 140000*5% 7000 7 year depreciation 35000 1 40000*5% P + 35000 2.00 35.000 Net written down value of assets 140000-35000 105000 Company A depreciation Depreciation as per Straight line method Depreciation recalculated as per company Marginal Tax Rate 88200 35000 20% 5320088200-35000) Increase in profit due to Decrease of depreciation However depreciation is Tax deductible expense, so consequently Tax expenditure would increase on this increase of Profit @ 20% So net Increase in Profit would be 10640 53200*20% 42560