Straight line depreciation takes the same deduction for each year in the depreci

Question

Straight line depreciation takes the same deduction for each year in the depreciable life of an asset, whereas MACRS is the standard form of accelerated depreciation, resulting in larger deductions in early years and smaller deductions in later years. Both methods result in the same total deductions. What is the most accurate statement about depreciation that follows?

A business will prefer straight line because it will maximize the present value of cash flow value from depreciation

A business will prefer MACRS because it will maximize the present value of cash flow value from depreciation

A business will prefer MACRS because it will minimize the present value of cash flow value from depreciation

A business will prefer straight line because it will minimize the present value of cash flow value from depreciation

A business will prefer straight line because it will maximize the present value of cash flow value from depreciation

A business will prefer MACRS because it will maximize the present value of cash flow value from depreciation

A business will prefer MACRS because it will minimize the present value of cash flow value from depreciation

A business will prefer straight line because it will minimize the present value of cash flow value from depreciation

Explanation / Answer

The answer is B

A business will prefer MACRS because it will maximize the present value of cash flow value from depreciation:

Depreciation is a term used in accounting, economics and finance, with reference to the fact that finite lived assets lose their value (i.e., depreciate) over time, and must be replaced. The factors relevant in determining the annual depreciation for a depreciable asset are the initial recorded amount (cost), estimated salvage value, estimated useful life, and depreciation method.

Accelerated depreciation allows deductions for declines in the value of an asset to occur at a rate above what is expected in practice (Review of Business Taxation, 1999). The total amount of depreciation allowed over an asset’s life is the same under both the nominal and accelerated depreciation regimes. Accelerated depreciation only allows the amount of depreciation taken each year to be higher during the earlier years of the life of an asset . The benefit of accelerated depreciation is confined to tax deferral. Companies generally pay taxes on profits: revenues minus expenses. There are various types of expenses, and depreciation is one of them. As a result, accelerated depreciation defers a company’s taxes during the earlier years of an asset’s life and increases them in later years. In many respects, this tax deferral property of accelerated depreciation will increase a firm’s demand for depreciable facilities and expand its financial capabilities for acquiring them.

Accelerated depreciation increases the present value of the depreciation deductions and thereby increases the after-tax present value of the net returns from investing in depreciable facilities.2 The increase in the present value of the depreciation deductions also represents a once-and-for-all reduction in the cost of the depreciable facilities involved

Accelerated depreciation thus reduces the risk of investment in depreciable facilities and effectively transfers cash flows from later years to earlier years

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