Cape Horn Company purchased a building on March 1, 1988, at a cost of $4,186,000. For financial reporting purposes, the building was being depreciated over 372 months at $10,500 per month. The remaining $280,000 of the cost was the estimated salvage value. The building was sold on October 31, 2007, for $7.2 million. An accelerated depreciation method allowed by the tax code was used to record depreciation for the tax return. As of October 31, 2007, the company had recorded $3.5 million of depreciation for tax purposes using an accelerated basis.
Determine
(a) the amount of gain or loss that should be reported on the income statement regarding the sale of the building,
(b) the amount of gain or loss that should be reported on the tax return regarding the sale of the building
(c) why a company would use straight-line depreciation for financial reporting purposes and accelerated depreciation for tax purposes. Discuss


Exercise 11-6

A. The amount of gain or loss that should be reported on the income statement regarding the sale of the building is the cost minus the residual value.$ 4,186,000-$280,000.=$3,906,000.
B. The amount of gain or loss that should be reported on the tax return regarding the sale of the building is the difference between the amount received and the book value of the asset at the time of sale $3,700,000=$7,200,0000-$3,500,000.
C. The reason why a company would use straight-line depreciation for financial reporting purposes and accelerated depreciation for tax purposes is that with accelerated depreciation a higher rate of expense can be recognized. This will lower the stated profits on the income statement. The company will pay tax on this “lower income,” thus increasing it’s cash flow; similarly, when a company uses straight line depreciation it uses a representational value of an asset who’s future value will decline on the balance sheet, over a given number of periods. The later example does not directly affect cash flow. Both are non cash expenses and both are recognized differently.

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Thanks!

Clough:

If you will read the entire, you will see my answer written at the bottom of the post. Please respond I need feed back, the teacher does not check our work before returning it to us so I have no Idea if I'm right or wrong.

Lester

Okay, I'm sorry! I didn't notice your answer! I will ask one of our Accounting Experts, codyman144, to take a look at your thread.

Thanks!

For (A) you want to do Sale price minus Net book value to calculate the gain. For net book value do Purchase price minus accumulated depreciation. Try that one again.

(B) Your on the right track but 3.5 mill is accumulated depreciation under tax not the net book value.

(C) For this again your mostly right but in the end the net tax effects are the same if the asset is held until fully depreciated. Given this what are you essentially doing with the taxes?

Please give it another try and let me know what you come up with.