Chapter 5: Depreciation and Corporate Tax

23年 4月 21日 1IE of CSU. Kim, Gyutai

Operating, Investing, and Financing Expenses

In chapter 5, we will learn the role of a depreciation cost and tax in an income statement, and how to calculate them.For the purpose, we need to be familiar with some of the important accounting principles.

Accrual Basis PrincipleThe accrual basis principle requires that revenues and expenses be recorded when, and as soon as , they are incurred, regardless of when cash flows (ex. prepaid expenses, or account receivable)Revenue Recognition PrincipleRecognize means to record an event for the purpose of reporting its effects in the financial statement.(1) Revue should be recognized at the time it is earned. In most cases, revenue is recognized and reported on the income statement at the time the earning process is essentially complete.(ex. unearned revenue account)(2) The inflow of assets associated with revenue does not have to be in the form of cash.(ex. account receivable, credit sales).23年 4月 21日 2IE of CSU. Kim, Gyutai

Cost PrincipleRequirements: Financial statement information must be based on costs incurred in business transactions. In applying the cost principle, cost is measured on a cash or cash equivalent basis(ex., vehicle traded value)Reasons for complying with the cost principle (1) It puts relevant information in the financial statement. (2) It is consistent with the objective principle."Most accountants believe that information based on actual costs is more reliable than information based on estimates of values.

Matching PrincipleWith matching principle, expenses should be reported on the income statement in the same accounting period as the revenues that were earned as a result of the expenses.Going-Concern PrincipleRequirements:Financial statements must reflect the assumption that the business will continue operating instead of being closed or sold.

23年 4月 21日 3IE of CSU. Kim, Gyutai

Operating Expenses: cash flows from operations include current sales revenue, cost of goods sold, and operating expenses. The interest portion of a loan repayment is deductible expense when determining net income, and it is included in the operating activities. cf: operating costs of manufacturers: (1) expensing of noninventoriable capitalized costs and (2) costs from all parts of the value chain, such as R&D, product design, marketing, and administrative that are expensed immediately as incurred.Investing Expenses: Three types of investment flows are associated with buying a piece of equipment: the original investment, salvage value at the end of its useful life, and working capital investment or recovery. It is generally assumed that the outflows for both capital investment and working capital investment are as if they take place in year 0.Financing Expense: Cash flows from financial activities are an amount of money borrowed and principal repayment. 23年 4月 21日 4IE of CSU. Kim, Gyutai

The Characteristics of DepreciationA depreciation cost is not a cash flow in a current year. Actually, it took place at which the equipment was purchased.There are two different kinds of depreciation costs depending on in which are dealt with.(1)We can think of a depreciation cost which is calculated into a product cost. For this case, we can freely calculate the depreciation cost.(2) There is other depreciation cost which should be calculated according to the tax rules and is absolutely independent of a product cost.To calculate the second depreciation cost, we need to consider the following five things in advance.

23年 4月 21日 5IE of CSU. Kim, Gyutai

Depreciable Property

1. It must be used in business or held for production income.

2. It must have a definite service life, and that life must be longer than 1 year

3. It must be something that wears out, decays, gets used up, becomes obsolete, or lose value from natural causes.

Depreciable Cost(cost basis): The cost basis of an asset represents the total cost that is claimed as an expense over an asset’s life, i.e., the sum of the annual depreciation expenses. It generally includes the actual cost of an asset and all other incidental expenses, such as freight, site preparation, and installation.

Five Factors to Consider

23年 4月 21日 6IE of CSU. Kim, Gyutai

Useful Life and Salvage Value: Over how many periods will an asset be useful to the company? What do published statutes allow you to choose as the life of an asset? These are the central questions to be answered when determining an asset’s depreciable life, i.e., the number of years over which an asset is to be depreciated. Historically, depreciation accounting included choosing a depreciable life that was based on the service life of an asset. Determining the service life of an asset, however, as often very difficult, and the uncertainty of these estimates often led to disputes between taxpayers and the central office of national tax administration. The salvage value is an asset’s estimated value at the end of its life. It is the amount eventually recovered through the sale, trade-in, or salvage. The eventual salvage value of an asset must be estimated when the depreciation schedule for the asset is established. Depreciation Methods: Book and Tax Depreciation One important distinction within the general definition of accounting depreciation should be introduced. Most firms calculate depreciation in two different ways, depending on whether the calculation is (1) intended for financial reports(book depreciation method), such as for the balance sheet or income statement or (2) for the Internal Revenue Service, for the purpose of calculating taxes(tax depreciation). 23年 4月 21日 7IE of CSU. Kim, Gyutai

23年 4月 21日 IE of CSU. Kim, Gyutai 8

구분 자산 또는 업종 구분 기준 내용연수 내용연수 범위

건축물 등

차량운반구 , 공구 , 기구 및 비품 5 년 4-6 년

선박 , 항공기 ( 운수업외의 업종에서 사용 하는 것에 한함 ) 12 년 9-15 년

연와조 , 블록조 , 콘크리트조 등의 건축물 20 년 15-25 년

철골 , 철근콘크리트조 등의 건축물 40 년 30-50 년

업종별 자산 ( 건축물 등을

제외한 나머지 유형고정자산 )

농업 , 건설업 , 도 소매업∙ , 정보처리 및 기타 컴퓨터 운용관련업 , 금융보험업 등 5 년 4-6 년

의복제조업 , 숙박 음식점업∙ , 여행알선∙운수 관련 서비스업 등 8 년 6-10 년

음식료품 , 섬유제품 , 가죽 가방 신발 제조업∙ ∙ , 자동차 및 트레일러 제조업 등 10 년 8-12 년

담배제조업 , 수상 항공운수업 등∙ 12 년 9-15 년

전기 , 가스 및 수도사업 20 년 15-20 년

시험연구용 자산광학기기 , 시험기기 , 측정기기 , 공구 , 기타 시험연구용 설비 3 년

건물부속설비 , 구축물 및 기계장치 5 년

국내세법에 의한 기준내용연수 및 내용연수범위 (2001.12.31 개정 )

23年 4月 21日 IE of CSU. Kim, Gyutai 9

자산종류 신고시 무신고시

1. 건축물과 무형고정자산 ( 광업권제외 ) 정액법 정액법

2. 건축물 외의 유형고정자산 ( 광업용 유형고정자산 제외 )

정률법 또는 정액법 정률법

3. 광업권 ( 해저광물 개발법에 의한 채취권 포함 )

정액법 또는 생산량비례법 생산량비례법

4. 광업용 유형고정자산 정률법정액법 또는 생산량비례법 생산량비례법

Ex 5.1] Cost Basis

Given] Purchase Cost(I)= 62,500,000 won, freight= 725,000won, installation labor=2,150,000won, space= 3,500,ooo won

Purchase Cost 62,500

+ Freight 725

+ Installation Labor 2,150

+ Preparation 3,500

Cost Basis 68,875

(unit: 000 won)

23年 4月 21日 10IE of CSU. Kim, Gyutai

Cost Basis

In general, there are three different kinds of book depreciation methods① Straight-Line Method②Accelerated Method③Units-of-Production Method

23年 4月 21日 IE of CSU. Kim, Gyutai 11

Book Depreciation

Principle It interprets a fixed asset as one that provides its service in a uniform fashion. The asset provides an equal amount of service in each year of its useful life. Equation Annual Depreciation Cost where , I= cost basis S= salvage value N= depreciable life (There is no allowance for a salvage value in a Korean Tax Law)

Book Value

NSIDn /)(

)(DnIBn

23年 4月 21日 12IE of CSU. Kim, Gyutai

Straight-Line Method

I = 1,000,000wonN = 5 yearsS = 0D = (I - S)/N

Annual Depreciation CostBook Value

(unit: ooowon)

D1

D2

D3

D4

D5

B1

B2

B3

B4

10,000

8,000

6,000

4,000

2,000

0 1 2 3 4 5

Total Depreciation Cost

n

n Dn Bn

1 2,000 8,000

2 2,000 6,000

3 2,000 4,000

4 2,000 2,000

5 2,000 0

23年 4月 21日 13IE of CSU. Kim, Gyutai

Ex 5.2] SL

Principle It recognizes that the stream of services provided by a fixed asset may decrease over time: in other works, the stream may be greatest in the first year of an asset’s service life and least in its last year. This may happen because the mechanical efficiency of an asset tends to decline with age. One of the most frequently used methods is called a “Declining Balance Method”. In order to calculate an annual depreciation cost, we first need to determine the depreciation ratio denoted by α. Equation Annual Depreciation Cost Book Value (According to a Korean Tax Law, only 5% of salvage value is allowed to justify calculating a depreciation cost)

1 nn BD

nn IB )1(

N/1)05.0(1

23年 4月 21日 14IE of CSU. Kim, Gyutai

Accelerated Method

I = 1,000,000wonN = 5 yearsS = 500,000won

Annual depreciation cost

Book value

n Dn Bn

0 10,000

1 4,507 5,493

2 2,476 3,017

3 1,360 1,657

4 746 911

5 411 500

D1

D2

D3D4

D5

B1

B2

B3 B4

10,000

8,000

6,000

4,000

2,000

0 1 2 3 4 5

Total Depreciation Cost

n

500B5

( 단위 :천원 )23年 4月 21日 15IE of CSU. Kim, Gyutai

Ex] DB

Ex 5.3] CFS Based Two Depreciation MethodsFinancial Date - Investment: 125,000,000 won - Project Life: 5years - Annual Revenue: 100,000,000 won - Annual Expenses: Labor: 20,000,000 won Material : 12,000,000 won Overhead: 8,000,000 won - Working Capital : 23,000,000 won - Financing: 625,000,000 won - Borrowing Rate: 10%, Equal Payment - Depreciation Methods: The SL and DB with a Depreciable Life of 8 Years - No Salvage Allowed - Tax Rate: 25% - MARR: 15%23年 4月 21日 16IE of CSU. Kim, Gyutai

Cash Flow Statements Based on the SL and DB Method

1. Depreciation Costs - Case 1: With the SL Method(the Same as in Ex 4.3)

- Case 2: With the DB Method(125,000 0)

15,625,0008

I SD won

N

31234.0)05.0(1 8/1

n Dep. Cost Book Value Cum. Dep. Cost1 125,000 0.31234=39,042.5 125,000-39,042.5=85,957.5 39,042.52 85,957.5 0.31234=26,848 85,957.5-26,848=59,109.5 65,890.53 59,109.5 0.31234=18,462.3 59,109.5-18,462.3=40,647.2 84,352.84 40,647.2 0.31234=12,695.7 40,647.2-12,695.7=27,951.5 97,048.55 27,951.5 0.31234=8,730.4 27,951.50-8.730.4=19,221.1 105,7796 19,221.1 0.31234=6,003.5 19,221.1-6,003.5=13,217.6 111,782.57 13,217.6 0.31234=4,128.4 13,217.6-4,128.4=9,089.2 115,9118 9,089.2 0.31234=2,838.9 9,089.2-2,838.9=6,250.3 125,000

(Unit: 000 won)

23年 4月 21日 17IE of CSU. Kim, Gyutai

Two Depreciation Costs

2. Gain(Loss) Taxes

- Case 1: with the SL Method(the Same as in Ex. 4.3)

1

( _ _ )

5 (15,625 / _ _ )

78,125,000

n

tt

Annual Depreciation Cost

Annual Depreciation Cost

won

Cumul ati ve Depreci ati on Cost

( _ ) - (Cumulative_Depreciation_Cost)

125,000 78,125 46,875,000

Initial Investment

won

Book Val ue

( _ ) (Book_Value)

50,000 46,875 3,125,000

Salvage Value

won

Gai n/ Loss

( arg _ _ ) ( / )

(0.25) (3,125) 781,300

M inal Tax Rae Gain Loss

won

Gai n/ Loss Taxes

23年 4月 21日 18IE of CSU. Kim, Gyutai

Gain(Loss) Taxes for the Sales of the Assets

- Case 2: With the DB Method

1

( _ _ )

(39,042.5 26,848 1,8462.3 12,695.4 8,730.4)

105,779,000

n

tt

Annual Depreciation Cost

won

Cumul ati ve_Depreci ati on_Cost

( _ _ )-(Cumulative_Depreciation_Cost)

125,000 105,779 19,221,000

Initial Investment Capital

won

Book_Val ue

( _ ) ( _ )

50,000 19,221 30,779,000

Salvage Value Book Value

won

Gai n/ Loss

( arg _ _ ) ( / )

(0.25) (30,779) 7,694,800

M inal Taxe Rate Gain Loss

won

Gai n/ Loss Taxes

23年 4月 21日 19IE of CSU. Kim, Gyutai

- Case 1: With the SL Method(the same as in Ex.4.3)- Case 2: With the DB Method

Input Data MARR 15% Dep. Method: DB with 8 yrs Rep. Periods 5 년

세율 25%부채이자율 : 10%

상환방법 :

원 리 균 등 상

환

Income

Statement 　 0 1 2 3 4 5

　 Rev 　 100,000 100,000 100,000 100,000 100,000

　 Exp: 　 　 　 　 　 　

　 Lab 　 20,000 20,000 20,000 20,000 20,000

　 Mat 　 12,000 12,000 12,000 12,000 12,000

　 Ind. Mfg 　 8,000 8,000 8,000 8,000 8,000

　 Dep 　 39,043 26,848 18,462 12,695 8,730

　 Int 　 6,250 5,226 4,100 2,861 1,499

　 Tax.Inc 　 14,708 27,926 37,438 44,444 49,771

　 Tax Rate25%) 　 3,677 6,982 9,359 11,111 12,443

　 NI 　 11,031 20,945 28,078 33,333 37,328

　 　 　 　 　 　 　 　

(unit:000won)

23年 4月 21日 20IE of CSU. Kim, Gyutai

Cash Flow Statement

CFS 　 　 　 　 　 　 　

　 Ope.Exp: 　 　 　 　 　 　

　 NI 　 11,031 20,945 28,078 33,333 37,328 　 Dep 　 39,037 26,846 18,462 12,696 8,731 　 Inv. Exp: 　 　 　 　 　 　

　 Inv. (125,000)　 　 　 　 　

　 Sal. 　 　 　 　 　 50,000 　 Gain Tax 　 　 　 　 　 (7,695)　 WC (23,000)　 　 　 　 23,000 　 Fin. Exp: 　 　 　 　 　 　

　 Fin 62,500 　 　 　 　 　

　 Prin. Rep 　 (10,237) (11,261) (12,626) (13,626) (14,988)　 NCF (85,500) 39,831 36,530 33,914 32,403 96,376

NPV(15%)= 65,498.39 AW(15%)= 19,539IRR= 40.1873%

(unit: 000won)

23年 4月 21日 21IE of CSU. Kim, Gyutai

Cash Flow Statement

item SL DBNPV(15%) 62,538.5 65,498AE(15%) 18,656 19,539IRR 37.763% 40.187%

The Economic Evaluation Indices of the SL and DB method

Depreciation MethodSL DBn (P/F,15%,N) Dep. Cost PV Dep. Cost PV12345

0.86960.75610.65750.57180.4972

15,62515,62515,62515,62515,625

13,587.511,814.110,273.48,934.47,768.8

39,03726,84618,46212,6968,731

33,946.620,298.312,138.87,259.64,341.1Total 78,125 52,378.2 105,772 77,984.4

The PV of the Depreciation Costs with the SL and DB method(unit: 000won)

23年 4月 21日 22IE of CSU. Kim, Gyutai

A Comparison of The Cash Flow Statements

- Principle What happens when a punch machine is run 1,670 hours one year and 780 hours the next, or when some of its output is shifted to a new machining center? This leads us to a consideration of another depreciation concept that views the asset as consisting of a bundle of service units. This concept does not assume that the service units will be consumed in a time-phased pattern. The cost of each service unit is the net cost of the asset divided by the total number of such units.- Equation Annual Depreciation CostEx 5.4] A units-of-Production MethodGiven] Cost Basis(I)=55,000,000won, Total Amount of Service=250,000 km, The Amount of Service Consumed for The Year=30,000kmSol] The Depreciation Cost for The Year

( _ _ _ _ )( _ ) ( _ )n

Annually Consumed Amount Of ServceD Cost Basis Salvage Value

Total _Amount_Of_Servi ce

1

30,000 3(55,000) (55,000) 6,600,000

250,000 25D won

23年 4月 21日 23IE of CSU. Kim, Gyutai

Units-of_Production Method

RevenueExpenses: COGS Depreciation Cost Operating CostTaxable IncomeTax

Net Income

Iter

23年 4月 21日 24IE of CSU. Kim, Gyutai

A Corporate Income Taxes

- A Current Tax Rate

- A New Tax Rate Established in 2008

Taxable IncomeBelow100mAbove 100mRate13%25%

Tax0 + 0.13*(Taxable Income)13m + 0.25*(Difference Between the Taxable Income and 100m)Tax. IncomeBelow 200mAbove 200m

Rate10.20%20%Tax0 + 0.102*(T. I)20.4 m + 0.25*(Difference Between the Taxable Income and 100m)

23年 4月 21日 25IE of CSU. Kim, Gyutai

Tax Rates

- marginal tax rate: tax rate applied to the last unit of income in case which the taxable income is below 100m, it is 13%. in case which the taxable income is above 100m, it is 25%- effective tax rate ex) suppose that a firm’s taxable income for year 2008 is 180m, then its tax turns out to 13,000+0.25(180,000-100,000)=33,000,000won Divide the total tax by the taxable income, then we obtain 33,000/180,000=18.3%23年 4月 21日 26IE of CSU. Kim, Gyutai

A Marginal and Effective Tax Rates

Ex 5.5] A Corporate Given] Revenue: 1.25b, depreciation cost:58m, rent: 20m, operating cost: 840mSol]

- Tax=13,000+0.25(332,000-100,000)=71m - Marginal Rate=25% - Effective Rate= 71,000/332,000=21.39%

Rev 1,250,000

Oper. Cost 840,000

Rent 20,000

Dep. 58,000

Taxable Income 332,000

(unit: 000won)

23年 4月 21日 27IE of CSU. Kim, Gyutai

Calculating the Tax