Reference no: EM132709535

Problem - Effect of depreciation on net income - Einstein Construction Co. specializes in building replicas of historic houses. Bree Andrus,president of Einstein Construction, is considering the purchase of various items of equipment on July 1, 20Y2, for $300,000. The equipment would have a useful life of five years and no residual value. In the past, all equipment has been leased. For tax purposes, Bree is considering depreciating the equipment by the straight-line method. She discussed the matter with her CPA and learned that although the straight-line method could be elected, it was to her advantage to use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes. She asked for your advice as to which method to use for tax purposes.

Required -

1. Compute depreciation for each of the years (20Y2, 20Y3, 20Y4, 20Y5, 20Y6, and 20Y7) of useful life by (a) the straight-line method and (b) MACRS. In using the straight-line method, one-half year's depreciation should be computed for 20Y2 and 20Y7. Use the MACRS rates presented in the chapter.

2. Assuming that income before depreciation and income tax is estimated to be $800,000 uniformly per year and that the income tax rate is 40%, compute the net income for each of the years 20Y2, 20Y3, 20Y4, 20Y5, 20Y6, and 20Y7 if (a) the straight-line method is used and (b) MACRS is used.

3. What factors would you present for Bree's consideration in the selection of a depreciation method?