Book vs tax depreciation Example Help

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Meaning of Book vs tax depreciation


Book depreciation the depreciation expense of a business is recorded in its financial statements and one of the depreciation method is followed to calculate that expense. Book depreciation differs in results from tax depreciation due to the number of depreciation methods available and even the useful life of assets is being estimated.

Under Tax depreciation method, depreciation expense of a business is recorded as per income tax returns guidelines. It states the useful lifespans for different classes of assets and the depreciation methods to use to calculate depreciation expense based on those useful lifespans.

A company must maintain separate records for both types of depreciation because of the calculation differences between tax depreciation and book depreciation.

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Book vs tax depreciation Example Explanation


Let us illustrate the concept with help of an example.

Example: Suppose the cost of a machine is $500,000 and expected useful is of 10 years and to have no salvage value at the end of the 10 years, the annual depreciation expense might be $50,000 each year or the company may estimate that the machine will be useful for only 5 years and have $100,000 salvage value. Here depreciation will be recorded as $80,000 ($400,000 divided by 5 years) each year.

But under tax depreciation the business has to calculate depreciation on the useful life of the asset as specified by IRS.Under IRS accelerated depreciation is followed in which depreciation in the first few years is more and less depreciation in the later years of the machine’s life. This results in less tax in the first few years of the asset’s life but will result in more taxes in the later years.

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