7 - Depreciation and Tax

7 - Depreciation and Tax - 8/17/2011 Depreciation and...

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8/17/2011 R B McCann 1 8/17/2011 Depreciation and Income Taxes "The hardest thing in the world to understand is the income tax." - Albert Einstein © R B McCann 2002-11 All rights reserved. It’s What You Keep That Matters © R B McCann - 2
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8/17/2011 R B McCann 2 8/17/2011 Economic Analysis Economic anal sis is based on cash flo Economic analysis is based on cash flow, not net income. We care about income tax because it has a significant impact on cash flows. We care about net income because it © R B McCann - 3 determines income tax. We care about depreciation because it affects the timing of income tax. Depreciation and Income Taxes Outline Outline: Net income review Book depreciation Tax depreciation Income tax © R B McCann - 4 Corporate and personal
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8/17/2011 R B McCann 3 8/17/2011 Net Income Review Net Income Sales minus © R B McCann - 6 Costs Net Income (Profit) equals
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8/17/2011 R B McCann 4 8/17/2011 Net Income Net Income = Revenue - Expenses Net Income Revenue Expenses Describes the profitability of a business over an interval of time . Computed according to Generally Accepted Accounting Practices (GAAP). Net income is an accounting concept © R B McCann - 7 It is not “real” money. It is certainly not cash. The Matching Principle The costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized. © R B McCann - 8
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8/17/2011 R B McCann 5 8/17/2011 Implications of Matching: Accrual Accounting Revenue is recognized when product is shipped and Revenue is recognized when product is shipped and invoiced. The customer often pays later. Cost of the product is recognized when the corresponding revenue is recognized. Prior to sale, the product is an asset called inventory. © R B McCann - 9 Non-product costs are recognized in the period they are incurred (called operating expenses). The cost of equipment is spread over its useful life. Called depreciation. Cost of Goods Sold All of the cost to purchase or produce the All of the cost to purchase or produce the goods or services reflected in revenue. Purchased material Direct labor Manufacturing overhead Produce 10 000 units and sell 8000 © R B McCann - 10 Produce 10,000 units and sell 8000: The cost of the 8000 is cost of goods sold. The cost of the remaining 2000 is in inventory.
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8/17/2011 R B McCann 6 8/17/2011 Operating Expenses Non-manufacturing expenses are recorded Non manufacturing expenses are recorded in the period in which they occur. Accounting assumes that the benefit is also received in that period. Typical categories: Research, Development and Engineering © R B McCann - 11 Sales and Marketing General and Administrative (G & A) Interest on Debt Depreciation Plant and equipment are assets when purchased Plant and equipment are assets when purchased.
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7 - Depreciation and Tax - 8/17/2011 Depreciation and...

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