Abco Pty Ltd is considering the purchase of $60 000 in tools. The manager estimates that the tools will generate $25 000 in savings during each year of a four-year life. The tools will be depreciated based on the following schedule.
The expected tax rate is 30 per cent. What is the tax effect of the depreciation in year 3? (Ignore time value of money)

Question

Abco Pty Ltd is considering the purchase of $60 000 in tools. The manager estimates that the tools will generate $25 000 in savings during each year of a four-year life. The tools will be depreciated based on the following schedule. 
The expected tax rate is 30 per cent. What is the tax effect of the depreciation in year 3? (Ignore time value of money)

Quizplus · Accepted Answer

In year 3, the tools will have a book value of $12,000 ($60,000 × 20%), which will be depreciated at the rate of 30% per year using the diminishing balance method. The depreciation expense in year 3 will be $3,600 ($12,000 × 30%). The tax effect of this depreciation expense will be $1,080 ($3,600 × 30%). Therefore, the tax effect of the depreciation in year 3 will be $2,620 ($3,600 - $1,080), which is option C.

Abco Pty Ltd Is Considering the Purchase of $60 000