CFA CFA Level 1 Accelerated depreciation tax shield?

Accelerated depreciation tax shield?

  • This topic has 5 replies, 4 voices, and was last updated Mar-17 by tacheman.
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      Plea for help – can someone explain how accelerated depreciation acts as a tax shield? I’m trying to solve this question and after an hour I’m just more confused. Help…?

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      #ERROR!

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      Here’s my take:

      1. Depreciation is an expense, therefore lowering taxable income (tax shield).
      2. Accelerated depreciation is a method of calculating annual depreciation whereby the depreciation expense is much higher in the earlier years of an asset, and reduces exponentially in later years.
      3. Although the end book value can be the same as the typical straight line method (e.g. $x flat depreciation a year for 3 years), and the total tax savings can be the same $ overall, having the tax savings earlier you gain more due to time value of money.

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      @TacheMan – yes the effect will reverse in later years when the depreciation expense is less (as the asset is of lower net book value), hence the “shield” on profit is less. But the earlier you get your tax savings, the better, due to time value of money. So for example, you could have reinvested those tax savings earlier and earned a rate of return.

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      @maroon5 @fabian thanks for the responses!

      because tax is only levied on profit, so if your profit is less (due to accelerated depreciation) you will get taxed less.

      But wouldn’t you get taxed more later on (because you don’t have any more assets to depreciate in later years)?

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      what @maroon5 said.

      fundamentally, accelerated depreciation decreases your profit for the year, thus you pay less tax for this year.

      Overall you do pay the same amount (assuming you make a profit every year etc) but TVM will still get you up tops.

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