The Greenville Company starts operations in Year One and buys several pieces of

Question

The Greenville Company starts operations in Year One and buys several pieces of equipment. All of this equipment is expected to last for ten years and have a residual value equal to 25 percent of cost. MACRS is properly used for tax purposes while straight-line depreciation is applied for financial reporting purposes. Based solely on the expensing of this equipment in Year One, which of the following statements is true? a. Reported net income for financial accounting purposes will be higher than taxable income. b. Reported net income for financial accounting purposes will be the same as taxable income. c. Reported net income for financial accounting purposes is likely to be lower than taxable income. d. Reported net income for financial accounting purposes must be lower than taxable income.

Explanation / Answer

Answer = A

Reported net income for financial accounting purposes will be higher than taxable income

Straight line method (Financial Purpose)

Depreciation per year = (Cost - Salvage value) / No. of Years

= (100% - 25%) / 10 Years

= 7.5% per annum

MACRS Method (Tax Purpose)

According to MACRS table, the rate for depreciation for 1st year is 10%

Conclusion

Under Straight line, Depreciation rate for 1st year is 7.5% whereas in MACRS depreciation rate is 10%,

So depreciation will be more under MACRS and this will lead to less profit AND

Depreciation under Straight line will be less and this will lead to more Profit.

So Profit under Financial accounting purpose will be more than profit under Tax Income

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