Question

As explained in this chapter, accounting theory allows firms to choose a depreciation method from several equally acceptable alternatives to allocate the cost of a long-term asset to expense over the useful life of the asset. In practice, however, most organizations use the straight-line method of depreciation for financial statement presentation and the Modified Accelerated Cost Recovery System (MACRS) for tax reporting purposes because the Internal Revenue Code allows firms to use an accelerated depreciation method on their tax returns, instead of the straight-line method they report under GAAP.

Discuss why a company would choose to use straight-line deprecation for financial reporting purposes and an accelerated method for tax purposes. Speculate on why the tax code might allow firms to accelerate depreciation for investments in productive resources.

Answer 1

Company will be choosing the straight line depreciation for normal reporting purposes because company will be having a lower rate of depreciation by having a straight line method and when the company will be trying to choose the modified accelerated cost recovery system, it will be trying to have a higher rate of depreciation chargeable on its products because the higher rate of depreciation will be having a lower tax effect as depreciation are tax exempted, so when there would be a higher rate of depreciation ,it will be meaning that the company will be having a more tax benefit associated with higher depreciation and it will be helpful for the company and it is also done because depreciation is done in initial years so there is higher amount of saving from the time value of money concept.

Higher amount of depreciation will be helping the firm in order to accelerate their profits and improve it because of depreciation.