test 3.docx - Cost Recovery and Tax Basis for Cost Recovery...

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Cost Recovery and Tax Basis for Cost Recovery Most businesses make a significant investment in property, plant, and equipment that is expected to provide benefits over a number of years. For both financial accounting and generally for tax accounting purposes, businesses must capitalize the cost of assets with a useful life of more than one year (on the balance sheet) rather than expense the cost immediately. Businesses are allowed to use various methods to allocate the cost of these assets over time because the assets are subject to wear, tear, and obsolescence. The method of cost recovery depends on the nature of the underlying asset. Depreciation is the method of deducting the cost of tangible personal and real property (other than land) over time. Amortization is the method of deducting the cost of intangible assets over time. Finally, depletion is the method of deducting the cost of natural resources over time. Exhibit 10-1 summarizes these concepts. EXHIBIT 10-1 Assets and Cost Recovery Asset Type Cost Recovery Method Personal property comprises tangible assets such as automobiles, equipment, and machinery. Depreciation Real property comprises buildings and land (although land is nondepreciable). Depreciation Intangible assets are nonphysical assets such as goodwill and patents. Amortization Natural resources are commodities that are considered valuable in their natural form such as oil, coal, timber, and gold. Depletion Generally, a significant portion of a firm’s assets consists of property, plant, equipment, intangibles, or even natural resources. In most cases, this holds true for small businesses like Teton and also for large publicly traded companies. For example, Exhibit 10-2 describes the assets held by Weyerhaeuser, a publicly traded timber company. As indicated in Exhibit 10-2, Weyerhaeuser has over $1.5 billion in property and equipment (net of depreciation) and $14.3 billion in timber (net of depletion), together comprising roughly 80 percent of its assets. EXHIBIT 10-2 Weyerhaeuser Assets Assets (in millions) per 2016 10-K Statement 2016 2015 Total current assets $ 1,622 $ 3,639 Property and equipment, net (Note 7) 1,562 1,233 Construction in progress 213 144 Timber and timberlands at cost, less depletion charged to disposals 14,299 6,552 Minerals and mineral rights, less depletion 319 14 Investments in and advances to equity affiliates (Note 8) 56 Goodwill 40 40 Deferred tax assets (Note 19) 293 254 Restricted assets held by special purpose entities (Note 8) 615 615 Other 224 229 Total assets $19,243 $12,720
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Businesses must choose accounting methods for the assets acquired during the year. Attention to detail is important because the tax basis of an asset must be reduced by the cost recovery deductions allowed or allowable.2 This means that if a business fails to deduct (by mistake or error) the allowable amount of depreciation for the year, the business still must reduce the asset’s tax basis by the depreciation the taxpayer could have deducted under the method the business is using to depreciate the asset. This means that the business will never receive a tax benefit for the amount of depreciation it failed to deduct.Page 10-3
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