{"id":249,"date":"2021-01-26T22:30:08","date_gmt":"2021-01-26T22:30:08","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/?post_type=chapter&#038;p=249"},"modified":"2021-05-22T00:32:40","modified_gmt":"2021-05-22T00:32:40","slug":"discount-rates","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/chapter\/discount-rates\/","title":{"raw":"Taxes and Depreciation","rendered":"Taxes and Depreciation"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Understand how long-term assets are depreciated and how that affects taxes<\/li>\r\n<\/ul>\r\n<\/div>\r\nLet\u2019s review the custom hat embroidery machine investment analysis from the previous reading:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Capital Investment<\/caption>\r\n<thead>\r\n<tr class=\"u-sr-only\">\r\n<th scope=\"col\">Description<\/th>\r\n<th scope=\"col\">Amount<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Embroidery machine<\/td>\r\n<td class=\"r\">$\u00a0 40,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Annual Cash Flows<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">YR 1<\/th>\r\n<th class=\"r\" scope=\"col\">YR 2<\/th>\r\n<th class=\"r\" scope=\"col\">YR 3<\/th>\r\n<th class=\"r\" scope=\"col\">YR 4<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Hats (2,500 * $4)<\/td>\r\n<td class=\"r\">$\u00a0 10,000<\/td>\r\n<td class=\"r\">$\u00a0 10,000<\/td>\r\n<td class=\"r\">$\u00a0 10,000<\/td>\r\n<td class=\"r\">$\u00a0 10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Shipping (2,500 * $1)<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 Total cash out<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Sales Revenue (2,500 * $10)<\/td>\r\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\">\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">Cash in<\/th>\r\n<th class=\"r\" scope=\"col\">Cash out<\/th>\r\n<th class=\"r\" scope=\"col\">Net Cash Flow<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Year 1<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 52,500<\/td>\r\n<td class=\"r\">$(27,500)<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 2<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 12,500<\/td>\r\n<td class=\"r\">$\u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 3<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 12,500<\/td>\r\n<td class=\"r\">$\u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 4<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 12,500<\/td>\r\n<td class=\"r\">$\u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 10,000<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nNow, let\u2019s look at this from a financial accounting perspective. For financial accounting, the cost of the equipment is \u201cdepreciated\u201d over the useful life of the asset, in this case, four years. Tax rules differ from Generally Accepted Accounting Principles, but we will use this \u201cstraight-line\u201d method here to compute the tax effect of the investment, sometimes called the \u201ctax shield\u201d. Entire volumes have been written on tax depreciation, so that is a topic for a much more advanced course.\r\n\r\nOur $40,000 machine has no residual value, so we will depreciate the entire purchase price by dividing it by 4 years. We could also divide by 10,000 units and depreciate the machine at $4 per unit, but in our example, this will give us the same result because we are assuming production and sales of 2,500 units per year.\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Income Statement (accrual basis)<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">YR 1<\/th>\r\n<th class=\"r\" scope=\"col\">YR 2<\/th>\r\n<th class=\"r\" scope=\"col\">YR 3<\/th>\r\n<th class=\"r\" scope=\"col\">YR 4<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales Revenue<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Cost of Goods Sold<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Gross Profit<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"1\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Expenses<\/strong><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 Depreciation<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 Shipping<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 \u00a0 Total expenses<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Net operating income<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Net operating income<\/td>\r\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\r\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\r\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\r\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"5\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Add back non-cash expense<\/strong><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 Depreciation<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Cash flow<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n&nbsp;\r\n\r\n<\/div>\r\nIn this case, our net operating income can be used for taxable income (there are many more adjustments between financial accounting and tax accounting, but we\u2019re just isolating depreciation here). Let\u2019s assume that our investor in this case has a marginal tax rate (rate paid on the next dollar or taxable income) of 25%.\r\n\r\nHere is an income statement including taxes at 25% without equipment depreciation:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Income Statement without depreciation<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">YR 1<\/th>\r\n<th class=\"r\" scope=\"col\">YR 2<\/th>\r\n<th class=\"r\" scope=\"col\">YR 3<\/th>\r\n<th class=\"r\" scope=\"col\">YR 4<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales Revenue<\/td>\r\n<td class=\"r\">$\u00a0 5,000<\/td>\r\n<td class=\"r\">$\u00a0 5,000<\/td>\r\n<td class=\"r\">$\u00a0 5,000<\/td>\r\n<td class=\"r\">$\u00a0 5,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Cost of Goods Sold<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Gross Profit<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"1\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Expenses<\/strong><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 Depreciation<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 -<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 Shipping<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 Total expenses<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Taxable income<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Income tax expense<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Net income after tax<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nAnd here is that same statement including depreciation:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\"><caption>Income Statement (accrual basis)<\/caption>\r\n<thead>\r\n<tr>\r\n<th class=\"r\" scope=\"col\"><\/th>\r\n<th class=\"r\" scope=\"col\">YR 1<\/th>\r\n<th class=\"r\" scope=\"col\">YR 2<\/th>\r\n<th class=\"r\" scope=\"col\">YR 3<\/th>\r\n<th class=\"r\" scope=\"col\">YR 4<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Sales Revenue<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<td class=\"r\">$\u00a0 25,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Cost of Goods Sold<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Gross Profit<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"1\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Expenses<\/strong><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 Depreciation<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<td class=\"r\">10,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 Shipping<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>\u00a0 \u00a0 \u00a0 Total expenses<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Taxable income<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Income tax expense<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Net income after tax<\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nNotice that by allowing companies to deduct the cost of the asset (in this case the embroidery machine) ratably over the life of the asset, the company gets to deduct that original investment to arrive at taxable income. The difference is called the tax shield or tax benefit.\r\n\r\nIn this case, the tax shield is $2,500 per year (the $3,125 in taxes without the benefit less the $625 in taxes with the benefit). Traditionally, the annual tax shield is calculated by multiplying the amount of the deduction ($10,000) by the tax rate (25%).\r\n\r\nOften, in calculating cash flows, the tax shield is included as a positive cash flow, since it represents a decrease in expense.\r\n\r\n<strong>Residual valu<\/strong>e is the amount of proceeds expected to be realized on the sale of the asset. It is not necessarily the market value, since an asset may be disposed of other than by selling.\r\n\r\nLet's check your understanding of depreciation and taxes.\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Question<\/h3>\r\n[ohm_question hide_question_numbers=1]221576[\/ohm_question]\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Understand how long-term assets are depreciated and how that affects taxes<\/li>\n<\/ul>\n<\/div>\n<p>Let\u2019s review the custom hat embroidery machine investment analysis from the previous reading:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Capital Investment<\/caption>\n<thead>\n<tr class=\"u-sr-only\">\n<th scope=\"col\">Description<\/th>\n<th scope=\"col\">Amount<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Embroidery machine<\/td>\n<td class=\"r\">$\u00a0 40,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Annual Cash Flows<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">YR 1<\/th>\n<th class=\"r\" scope=\"col\">YR 2<\/th>\n<th class=\"r\" scope=\"col\">YR 3<\/th>\n<th class=\"r\" scope=\"col\">YR 4<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Hats (2,500 * $4)<\/td>\n<td class=\"r\">$\u00a0 10,000<\/td>\n<td class=\"r\">$\u00a0 10,000<\/td>\n<td class=\"r\">$\u00a0 10,000<\/td>\n<td class=\"r\">$\u00a0 10,000<\/td>\n<\/tr>\n<tr>\n<td>Shipping (2,500 * $1)<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 Total cash out<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td>Sales Revenue (2,500 * $10)<\/td>\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-double\">$\u00a0 25,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">Cash in<\/th>\n<th class=\"r\" scope=\"col\">Cash out<\/th>\n<th class=\"r\" scope=\"col\">Net Cash Flow<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Year 1<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 52,500<\/td>\n<td class=\"r\">$(27,500)<\/td>\n<\/tr>\n<tr>\n<td>Year 2<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 12,500<\/td>\n<td class=\"r\">$\u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td>Year 3<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 12,500<\/td>\n<td class=\"r\">$\u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td>Year 4<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 12,500<\/td>\n<td class=\"r\">$\u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 10,000<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>Now, let\u2019s look at this from a financial accounting perspective. For financial accounting, the cost of the equipment is \u201cdepreciated\u201d over the useful life of the asset, in this case, four years. Tax rules differ from Generally Accepted Accounting Principles, but we will use this \u201cstraight-line\u201d method here to compute the tax effect of the investment, sometimes called the \u201ctax shield\u201d. Entire volumes have been written on tax depreciation, so that is a topic for a much more advanced course.<\/p>\n<p>Our $40,000 machine has no residual value, so we will depreciate the entire purchase price by dividing it by 4 years. We could also divide by 10,000 units and depreciate the machine at $4 per unit, but in our example, this will give us the same result because we are assuming production and sales of 2,500 units per year.<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Income Statement (accrual basis)<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">YR 1<\/th>\n<th class=\"r\" scope=\"col\">YR 2<\/th>\n<th class=\"r\" scope=\"col\">YR 3<\/th>\n<th class=\"r\" scope=\"col\">YR 4<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales Revenue<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<\/tr>\n<tr>\n<td>Cost of Goods Sold<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>Gross Profit<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<\/tr>\n<tr>\n<td colspan=\"1\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Expenses<\/strong><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 Depreciation<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 Shipping<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 \u00a0 Total expenses<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>12,500<\/td>\n<\/tr>\n<tr>\n<td>Net operating income<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a02,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<tr>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td>Net operating income<\/td>\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\n<td class=\"r\">$\u00a0 \u00a02,500<\/td>\n<\/tr>\n<tr>\n<td colspan=\"5\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Add back non-cash expense<\/strong><\/td>\n<\/tr>\n<tr>\n<td>\u00a0 Depreciation<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>Cash flow<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 12,500<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<\/div>\n<p>In this case, our net operating income can be used for taxable income (there are many more adjustments between financial accounting and tax accounting, but we\u2019re just isolating depreciation here). Let\u2019s assume that our investor in this case has a marginal tax rate (rate paid on the next dollar or taxable income) of 25%.<\/p>\n<p>Here is an income statement including taxes at 25% without equipment depreciation:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Income Statement without depreciation<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">YR 1<\/th>\n<th class=\"r\" scope=\"col\">YR 2<\/th>\n<th class=\"r\" scope=\"col\">YR 3<\/th>\n<th class=\"r\" scope=\"col\">YR 4<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales Revenue<\/td>\n<td class=\"r\">$\u00a0 5,000<\/td>\n<td class=\"r\">$\u00a0 5,000<\/td>\n<td class=\"r\">$\u00a0 5,000<\/td>\n<td class=\"r\">$\u00a0 5,000<\/td>\n<\/tr>\n<tr>\n<td>Cost of Goods Sold<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>Gross Profit<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<\/tr>\n<tr>\n<td colspan=\"1\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Expenses<\/strong><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 Depreciation<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 &#8211;<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 Shipping<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 Total expenses<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>Taxable income<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td>Income tax expense<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 3,125<\/td>\n<\/tr>\n<tr>\n<td>Net income after tax<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 9,375<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>And here is that same statement including depreciation:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<caption>Income Statement (accrual basis)<\/caption>\n<thead>\n<tr>\n<th class=\"r\" scope=\"col\"><\/th>\n<th class=\"r\" scope=\"col\">YR 1<\/th>\n<th class=\"r\" scope=\"col\">YR 2<\/th>\n<th class=\"r\" scope=\"col\">YR 3<\/th>\n<th class=\"r\" scope=\"col\">YR 4<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Sales Revenue<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<td class=\"r\">$\u00a0 25,000<\/td>\n<\/tr>\n<tr>\n<td>Cost of Goods Sold<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>Gross Profit<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>15,000<\/td>\n<\/tr>\n<tr>\n<td colspan=\"1\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Expenses<\/strong><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 Depreciation<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<td class=\"r\">10,000<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 Shipping<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>\u00a0 \u00a0 \u00a0 Total expenses<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 12,500<\/td>\n<\/tr>\n<tr>\n<td>Taxable income<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>\u00a0 \u00a0 \u00a0 2,500<\/td>\n<\/tr>\n<tr>\n<td>Income tax expense<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 625<\/td>\n<\/tr>\n<tr>\n<td>Net income after tax<\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$\u00a0 \u00a01,875<span class=\"u-sr-only\">Double line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>Notice that by allowing companies to deduct the cost of the asset (in this case the embroidery machine) ratably over the life of the asset, the company gets to deduct that original investment to arrive at taxable income. The difference is called the tax shield or tax benefit.<\/p>\n<p>In this case, the tax shield is $2,500 per year (the $3,125 in taxes without the benefit less the $625 in taxes with the benefit). Traditionally, the annual tax shield is calculated by multiplying the amount of the deduction ($10,000) by the tax rate (25%).<\/p>\n<p>Often, in calculating cash flows, the tax shield is included as a positive cash flow, since it represents a decrease in expense.<\/p>\n<p><strong>Residual valu<\/strong>e is the amount of proceeds expected to be realized on the sale of the asset. It is not necessarily the market value, since an asset may be disposed of other than by selling.<\/p>\n<p>Let&#8217;s check your understanding of depreciation and taxes.<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Question<\/h3>\n<p><iframe loading=\"lazy\" id=\"ohm221576\" class=\"resizable\" src=\"https:\/\/ohm.lumenlearning.com\/multiembedq.php?id=221576&theme=oea&iframe_resize_id=ohm221576\" width=\"100%\" height=\"150\"><\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-249\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Taxes and Depreciation. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":364389,"menu_order":10,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Taxes and Depreciation\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-249","chapter","type-chapter","status-publish","hentry"],"part":37,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/249","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/users\/364389"}],"version-history":[{"count":5,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/249\/revisions"}],"predecessor-version":[{"id":1891,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/249\/revisions\/1891"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/parts\/37"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/249\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/media?parent=249"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=249"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/contributor?post=249"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-managerialaccounting\/wp-json\/wp\/v2\/license?post=249"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}