Strategic Considerations for Switching Depreciation Methods- Balancing Immediate Tax Benefits with Long-Term Financial Impact

Strategic Considerations for Switching Depreciation Methods- Balancing Immediate Tax Benefits with Long-Term Financial Impact

I would recommend the use of the straight-line depreciation method. A double declining method looks good since it reduces taxation in the short run, but it will not be sustainable in the long run. In this case, the company’s sales are projected to increase dramatically in the next five years. An increase in taxes will accompany the increase in sales. Therefore, the company needs a depreciation method that will guarantee tax breaks in the future, and the straight-line method comes in handy (Ibarra, 2013).

The straight-line depreciation method is also preferred due to the uncertainty concerning the company’s future cash flow. Although sales are estimated to rise, there is no certainty whether there will be a healthy cash flow or otherwise. It is, therefore, safe to use the straight-line depreciation method, which lowers the present value tax liability. Another factor that justifies the use of the straight-line method is the progressive tax system. The fact that the company expects growing future cash flows also reinforces the use of the straight-line depreciation method (Ackermann et al., 2016).

Moreover, the straight-line depreciation method is also suitable since it offers different schedules for different assets owned by the company. As a result, tax rates would eventually vary. A good example is the American system, where effective tax rates for general equipment for businesses that use the straight-line depreciation method are 4 percent to 15 percent lower. On the other hand, the effective tax rates for assets like buildings are usually 4 percent lower (Ackermann et al., 2016). Reduced tax liability is the objective of every business.

References

Ackermann, H., Fochmann, M., & Wolf, N. (2016). The Effect of Straight-Line and Accelerated Depreciation Rules on Risky Investment Decisions—An Experimental Study. International Journal of Financial Studies, 4(4), 19. https://doi.org/10.3390/ijfs4040019

Ibarra, V. C. (2013). The straight-line depreciation method is used by selected companies and educational institutions in the Philippines. Journal of Modern Accounting and Auditing, 9(4), 480.

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Your company has always depreciated assets using the straight-line method. Your tax accountant has explained that switching to the double-declining balance method would minimize taxes in the current year. Still, you are concerned about the impact this change would have on the value of long-term assets on the balance sheet and future tax liabilities.

Strategic Considerations for Switching Depreciation Methods- Balancing Immediate Tax Benefits with Long-Term Financial Impact

Respond to the following in a minimum of 175 words:

Assuming your projected sales (and, therefore, tax bracket) are predicted to increase dramatically over the next 5 years, what should you do?