Question

Walmart purchased a piece of equipment on January 1, 2015 for $34,000,000. Management estimates that the equipment will have a useful life of eight years and a $4,000,000 salvage value. The depreciation expense recorded for tax purposes is computed using the double-declining balance method of depreciation. The company uses the straight-line method of depreciation for reporting purposes. The company’s fiscal year from January 1 toDecember 31.

Calculate the amount of depreciation expense for reporting purposes for the year ending December 31, 2020 (i.e., the 6th full year of depreciation). Then calculate the amount of depreciation expense for tax purposes for the year ending December 31, 2020 (i.e., the 6th full year of depreciation). Use this information to determine the correct answers to the following two (2) questions:

1. Will a deferred tax asset or a deferred tax liability be created for the year ending December 31, 2020 as a result of the depreciation recorded for tax and financial reporting purposes?

   1. Deferred tax asset

   2. Deferred tax liability

2. According to the Double Declining Balance depreciation schedule that Walmart used compute depreciation expense for tax purposes, what was the ending book value of this piece of equipment on December 31, 2017? Round your answer to 0 decimal places.

3. According to the Straight-Line method of depreciation that Walmart used compute depreciation expense for reporting purposes, what was the ending book value of this piece of equipment on December 31, 2019? Round your answer to 0 decimal places.

4. Assuming that the company’s tax rate is 21%, what dollar amount (as an absolute value) will be added (if your answer to the prior question was “a”) or subtracted (if your answer to the prior question was “b”) to the deferred tax account on the December 31, 2020 balance sheet as a result of the depreciation timing difference? Round your answer to 0 decimal places.

Answer 1

To answer the above questions in one go, lets prepare the following working first:

WN 1. Depreciation under Financial Reporting (Straight Line Method):

Under this method, depreciation is fixed throughout the life of the asset.

Schedule of Depreciation over 8 years:

WN 2. Depreciation under Tax Reporting (Double Declining Method):

Under this method depreciation is computed at double the rate than the normal depreciation on the beginning value of the asset in a particular year.

Rate of Depreciation = 1 / Life of Asset = 100 / 8 = 12.50%

Double declining rate = 12.50% x 2 = 25%

Schedule of Depreciation over 8 years:

Now lets answer the questions based on above working notes:

1. The amount of depreciation expense for financial reporting purposes for the year ending December 31, 2020:

$ 3,750,000                (As per WN 1)

2. The amount of depreciation expense for tax reporting purposes for the year ending December 31, 2020:

$ 2,017,090                (As per WN 2)

3. Will a deferred tax asset or a deferred tax liability be created for the year ending December 31, 2020 as a result of the depreciation recorded for tax and financial reporting purposes?

Deferred Tax Asset / Liability is created because of timing difference between the profit as per financial statements and profit as per the tax laws. If the profit due to timing difference is higher as per financials when compared with taxable profit, then it will create a Deferred Tax Liability, similarily if the profit due to timing difference is lower as per financials when compared with taxable profit, then it will create a Deferred Tax Asset.

In the above case, Depreciation results in a timing difference, due to different methods used.

In the 6th year, since the depreciation expense is higher in financial statements, which means that the profits are lower as per books when compared with taxable profit, it will result in Deferred Tax Asset for the year ending December 31, 2020.

4. Ending book value of this piece of equipment on December 31, 2017 under Double Declining Balance Depreciation Method:

$ 19,125,000 (as per WN 2) (Year 2)

5. Ending book value of this piece of equipment on December 31, 2019 under Straight Line Depreciation Method:

$ 19,000,000 (as per WN 1) (Year 4)

6. Assuming that the company’s tax rate is 21%, dollar amount (as an absolute value) that will be added or subtracted to the deferred tax account on the December 31, 2020

Since Deffered Tax Asset will be created, following amount will be Added to the deferred tax account on the December 31, 2020

Depreciation as per Financial Statements: $ 3,750,000                (As per WN 1)

Depreciation as per Taxation Laws: $ 2,017,090               (As per WN 2)

Difference: $ 1,732,910

at 21% Deferred Tax Asset to be created: $ 363,911.10

$ 363,911 will be added to the deferred tax account on the December 31, 2020.

The amounts computed might differ due to rounding off. Kindly consider the same.

For any clarifications feel free to ask.