Griffith Delivery Service purchased a delivery truck for $33,600. The truck has

Question

Griffith Delivery Service purchased a delivery truck for $33,600. The truck has an estimated useful life of six years and no salvage value. For purposes of preparing financial statements, Griffith is planning to use straight-line depreciation. For tax purposes, Griffith follows MACRS. Depreciation expense using MACRS is $6,720 in Year 1, $10,750 in Year 2, $6,450 in Year 3, $3,870 in each of Years 4 and 5, and $1,940 in Year 6.

1. What is the difference between straight-line and MACRS depreciation expense for each of the six years?

2. Griffith’s president has asked why you use one method for the books and another for tax calculations. ‘‘Can you do this? Is it legal? Don’t we take the same total depreciation either way?’’ he asked. Write a brief memo answering his questions and explaining the benefits of using two methods for depreciation.

Explanation / Answer

Solution:

1. In straight line depreciation, the purchase price of the asset is divided into the useful life of the asset, so the depreciation in each year is same. In MACRS system depreciation, the depreciation is larger in early years and lower in later years. There are two methods for MACRS depreciation: GDS (General depreciation system) and (ADS) Alternate depreciation system.
The difference in the expenses of two methods are as follow:

2. Depreciation is a necessary expense for all businesses with fixed assets excluding land. It is a non cash expense & is accounted in the income statement.
MACRS or Modified Accelerated Cost Revovery System is the method adopted by IRS after 1986 for the purpose tax calculation. Under this method, an asset's depreciable life is multiplied by a percentage obtained from one of the tables developed by IRS.   
Straight line depreciation is the method generally adopted for books, where the purchase price of the asset is divided into the useful life of the asset, so the depreciation in each year is same

Now, method used for books recording is based on the matching principle of accounting whereas the method used for tax calculation is the method adopted by the internal revenue service of the country. Hence, there can be two different methods for both the purposes. It is legal and is followed in many of the companies.

The advantages of straight line depreciation are:
1. It offers simplicity and does not require complex calculation
2. It allows in the calculation of future profits quite easily
3. The benefit of depreciation is received evenly over the life of the asset

The advantages of MACRS depreciation are:
1. This method classifies each asset into a preset category with defined depreciation limits
2. This method shortens the recovery period and allows for 100% depreciation

Year 1 2 3 4 5 6 Straight line depreciation (33,600/6) 5,600 5,600 5,600 5,600 5,600 5,600 MACRS depreciation (given) 6,720 10,750 6,450 3,870 3,870 1,940 Difference -1,120 -5,150 -850 1,730 1,730 3,660

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