Use the information below to answer the following questions:
Pottery Ltd is trying to decide whether to use straight-line or reducing balance depreciation for its assets for both accounting and tax purposes. If it used straight-line, the depreciation expense for the first year would be $750 000, but if it used reducing balance at the rate allowable for taxation purposes, the expense would be $1 125 000. The company’s income tax rate is 40%.
-What would be the effect on net profit after tax if the reducing balance method were used rather than the straight-line method?

Question

Use the information below to answer the following questions:
Pottery Ltd is trying to decide whether to use straight-line or reducing balance depreciation for its assets for both accounting and tax purposes. If it used straight-line, the depreciation expense for the first year would be $750 000, but if it used reducing balance at the rate allowable for taxation purposes, the expense would be $1 125 000. The company’s income tax rate is 40%. 
-What would be the effect on net profit after tax if the reducing balance method were used rather than the straight-line method?

Quizplus · Accepted Answer

Using the reducing balance method results in a higher depreciation expense of $1,125,000 compared to $750,000 with the straight-line method. The difference is $375,000. With a 40% tax rate, the tax saving is $150,000 (40% of $375,000), leading to a net profit reduction of $225,000.

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