Capital Cos ts : Capitalizatio n, Dep reciatio n and
Taxation
F ebru ary 23. 2004
From an accounting pe rspe ctive , there are two categories of costs:
• ‘Expensed’ costs
– Item s that are used up quickly; costs recovered out of current revenues
• ‘C apitalized’ costs
– Long lifetime items; costs recovered progressively th ro ughout the expected lifetim e
D epreciatio n Exam ple : Pizz a D eliver y B usiness
Sales: $20,000/yr Car purchase: $6,000
Operating expenses: $10,000 Car lifetime: 4 yrs
N et salv age value: $0
Income statements (I): E xpensing the car purchase
|
Yea r 1 |
Yea r 2 |
Yea r 3 |
Yea r 4 |
|
|
Operating Revenues |
20,000 |
20,000 |
20,000 |
20,000 |
|
Operating Expenses |
10,000 |
10,000 |
10,000 |
10,000 |
|
Car Purchase |
6,000 |
-- |
-- |
-- |
|
Operating Income (=operating revenues – operating expenses) |
4,000 |
10,000 |
10,000 |
10,000 |
|
Net Cash Flow |
4,000 |
10,000 |
10,000 |
10,000 |
Incom e Statem ents (II): C apitalizing the car purchase
& straight-line depreciation
|
Yea r 1 |
Yea r 2 |
Yea r 3 |
Yea r 4 |
|
|
Operating Revenues |
20,000 |
20,000 |
20,000 |
20,000 |
|
Operating Expenses |
10,000 |
10,000 |
10,000 |
10,000 |
|
Operating Income |
10,000 |
10,000 |
10,000 |
10,000 |
|
Depreciation allowance |
1500 |
1500 |
1500 |
1500 |
|
Net income (before taxes) = Operating |
8,500 |
8,500 |
8,500 |
8,500 |
|
income – depreciation |
||||
|
allowance |
||||
|
Net cash flow |
4000 |
10,000 |
10,000 |
10,000 |
Income statements (III): Expensing the car purchase; taxe s included
|
Yea r 1 |
Yea r 2 |
Yea r 3 |
Yea r 4 |
|
|
Op. Revenues (OR) |
20000 |
20,000 |
20,000 |
20,000 |
|
Op. Expenses (OE) |
10000 |
10,000 |
10,000 |
10,000 |
|
Car Purchase |
6000 |
|||
|
Op. Income (OI) |
4000 |
10000 |
10000 |
10000 |
|
Taxable Income (TI) |
4000 |
10000 |
10000 |
10000 |
|
(= OR-OE-‘other |
||||
|
deductible items’) |
||||
|
Taxes (T= TI* ) |
1200 |
3000 |
3000 |
3000 |
|
( = 30%) |
||||
|
Net Income After Taxes |
2800 |
7000 |
7000 |
7000 |
|
(=TI – T) |
||||
|
Net Cash Flow |
2800 |
7000 |
7000 |
7000 |
|
(= Total cash in – |
||||
|
total cash out) |
Incom e Statem ents (IV ): C apitalizing and depreciating the
car purchase; taxe s included
(Straight-line depreciation assum ed)
|
Yea r 1 |
Yea r 2 |
Yea r 3 |
Yea r 4 |
|
|
Op. Revenues (OR) |
20000 |
20,000 |
20,000 |
20,000 |
|
Op. Expenses (OE) |
10000 |
10,000 |
10,000 |
10,000 |
|
Op. Income (OI) |
10000 |
10000 |
10000 |
10000 |
|
Depreciation |
1500 |
1500 |
1500 |
1500 |
|
Allowance (D) |
||||
|
Taxable Income |
8500 |
8500 |
8500 |
8500 |
|
(TI = OR-OE-D) |
||||
|
Taxes (T= TI* ) |
2550 |
2550 |
2550 |
2550 |
|
( = 30%) |
||||
|
Net Income After Taxes |
5950 |
5950 |
5950 |
5950 |
|
(ATNI =TI – T) |
||||
|
Net Cash Flow |
1450 |
7450 |
7450 |
7450 |
|
(NCF = Total cash in |
||||
|
– total cash out) |
E xpensing the car cost
Yea r 1 Yea r 2 Yea r 3 Yea r 4
Op. Revenues (OR) 20000 20,000 20,000 20,000
Op. Expenses (OE) 10000 10,000 10,000 10,000
Car Purchase 6000
Op. Income (OI) 4000 10000 10000 10000
Taxable Income (TI) 4000 10000 10000 10000 (= OR-OE-‘other
deductible items’)
Taxes (T= TI* ) 1200 3000 3000 3000
( = 30%)
D epreciating the car cost
Yea r 1 Yea r 2 Yea r 3 Yea r 4
Op. Revenues (OR) 20000 20,000 20,000 20,000
Op. Expenses (OE) 10000 10,000 10,000 10,000
Op. Income (OI) 10000 10000 10000 10000
Depreciation 1500 1500 1500 1500
Allowanc e (D )
Taxable Income 8500 8500 8500 8500 (TI = OR-OE-D)
Taxes (T= TI* ) 2550 2550 2550 2550
( = 30%)
Net Income After 2800 7000 7000 7000 Taxes
(=TI – T)
Net Income After 5950 5950 5950 5950 Taxes
(ATNI =TI – T)
Net Cash Flow 2800 7000 7000 7000
(= Total cash in –
tota l cas h out )
Total taxes = $10200
Net Cash Flow 1450 7450 7450 7450
(NCF = Total cash in
– tota l cas h out )
Total taxes = $10200
E xpensing the car cost
Yea r 1 Yea r 2 Yea r 3 Yea r 4
Op. Revenues (OR) 20000 20,000 20,000 20,000
Op. Expenses (OE) 10000 10,000 10,000 10,000
D epreciating the car cost
Yea r 1 Yea r 2 Yea r 3 Yea r 4
Op. Revenues (OR) 20000 20,000 20,000 20,000
Op. Expenses (OE) 10000 10,000 10,000 10,000
Car Purchase 6000
Op. Income (OI) 10000
10000
10000
10000
Op. Income (OI) 4000 10000 10000 10000
Depreciation
1500
1500
1500
1500
Allowanc e (D )
Taxable Income (TI) 4000 10000 10000 10000
(= OR-OE-‘other deductible items’)
Taxes (T= TI* ) 1200 3000 3000 3000
( = 30%)
Taxable Income
(TI = OR-OE-D)
Taxes (T= TI* ) ( = 30%)
8500
2550
8500
2550
8500
2550
8500
2550
Net Income After 2800 7000 7000 7000
Taxes (=TI – T)
Net Income After 5950 5950 5950 5950
Taxes
(ATNI =TI – T)
Net Cash Flow 2800 7000 7000 7000
(= Total cash in –
Net Cash Flow
(NCF = Total cash in
1450 7450 7450 7450
tota l cas h out ) – tota l cas h out )
NPV(@10%/yr) = -6000 + 8800/1.1 + 7000/1.1 2 + 7000/1.1 3 +
7000/1.1 4
= $17,825
NPV(@0%/yr) = -6000 + 7450/1.1 + 7450/1.1 2 + 7450/1.1 3 + 7450/1.1 4
= $17,615
Conclusion : On an after-tax NPV basis, the business would prefer to expense the car cost. But this is not permitted by the IRS!
Example : Capita liz in g an d depre ciatin g th e car ; de bt
fina ncing
Sales: $20,000/yr Car purchase: $6,000
Operating expenses: $10,000 Car lifetime: 4 yrs
N et salv age value: $0 Car loan: $4000 Loan term : 4 years
Repaym ent: Equal principal repaym ents
at end of year
Incom e Statement : Capitalizatio n an d (straigh t line ) depreciatio n o f the ca r + deb t financing
|
T=0 |
En d o f Yea r 1 |
En d o f Ye a r 2 |
En d o f Yea r 3 |
En d o f Yea r 4 |
|
|
Operating Revenue (OR) |
20000 |
20000 |
20000 |
20000 |
|
|
Operating Costs (OC) |
10000 |
10000 |
10000 |
10000 |
|
|
Operating Income (OI = OR-OC) |
10000 |
10000 |
10000 |
10000 |
|
|
Depreciation allowance (D) |
1500 |
1500 |
1500 |
1500 |
|
|
Interest payment (IP) |
400 |
300 |
200 |
100 |
|
|
Taxable income (TI = OI – D – IP) |
8100 |
8200 |
8300 |
8400 |
|
|
Taxes (@ 30% of TI) |
2430 |
2460 |
2490 |
2520 |
|
|
After-tax net income |
5670 |
5700 |
5730 |
5760 |
|
|
Principal repayment (PR) |
1000 |
1000 |
1000 |
1000 |
|
|
Net cash flow (NCF = OR – OC – IP – PR) |
-2000 |
6170 |
6240 |
6310 |
6380 |
|
Sales & other oper ating rev enue |
$303,000 |
||
|
Less s ales return & a l low ances |
(3,000) |
||
|
Cost of goods sold |
300,000 |
||
|
La bor |
120,000 |
||
|
Materials |
60,000 |
||
|
Ov erhea d |
8,000 |
||
|
D epreciation |
20,000 |
||
|
T ota l |
(208,000) |
||
|
Gross p rofit |
92,000 |
||
|
Oper ating e xpenses |
|||
|
Selling |
15,720 |
||
|
Gener al administr ation |
29,000 |
||
|
Lea se pa yments |
14,000 |
||
|
T ota l |
58,720 |
(58,720) |
|
|
Net o per ating p rofit |
33,280 |
||
|
Nonoper ating r ev enues |
0 |
||
|
Nonoper ating e xpenses |
|||
|
Interest p a yments |
(5,200) |
||
|
Net i ncome before tax es |
28,080 |
||
|
Income tax es (30%) |
(8,424) |
||
|
Net i ncome |
$19,656 |
||
|
Sta tement of retained earnings |
|||
|
Ca sh d ividends |
|||
|
Preferred stock (per share, $6) |
600 |
||
|
Common stock (per share, $.95) |
9,45 6 |
||
|
T ota l d ividends |
$10,056 |
||
|
Reta ined ea rnings Beginning of y ear (1/1/20xx) |
32,800 |
||
|
Current y ear |
9,600 |
||
|
End of y ear |
$42,400 |
2/23/04
11
Sunset Inc.
INCOME STATEMENT & RETAINED EARNINGS
(For Year Ended December 31, 20xx)
Inco me s tatement
Net s ales
Earnings per sha re of common stock
Net a pplicable income, (19,656 - 600)/10,000
$1.9 1
Nuclear Energy Eco no mics and Policy Analysis
Derivation of composite income tax rate: Non -deductibility of federal taxes from state taxes
Let:
= composite tax rate
F = federal tax rate
s = state tax rate
T F = federal taxes due T s = state ta xes due R = revenues received
X = operating and maintenance expenses B = bond interest due
D = depreciation allowance
Then:
Thus,
T F = F (R – X – D – B – T s )
T s = s (R – X – D – B)\
T F = F (1- s )(R – X – D – B )
And total taxes, T = T F + T S = (R – X – D – B)[ F (1- s ) + s ] And if we define the tot al tax rate, , as
T = (R – X – D – B)
= [ F (1- s ) + s ]
We have that
2/23/04 Nuclear Energy Economics and 12
Policy Analysis