Free Research Paper On Depreciation And Disclosure Requirements
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Research Paper: Tax
Research Paper: Tax
Generally, depreciation refers to an annual deduction of tax that permits a company or organization (ABC) to recover the cost of a property (in this case, the research facility). It allows for tear and wear, and deterioration as well as obsolescence (Internal Revenue Service, 2014; Financial Web, 2015). In this regard, ABC has some room for depreciation on the grounds of obsolescence. It makes sense that ABC settles on depreciation as a strategy to avoid losing too much in the taxation of the facility, which will be of no value in just five years. According to the Internal Revenue Service (2014), when a property has been retired from service, the owner stops to depreciate it even if they have not fully recovered the cost or other basis. In other words, in five years, ABC will stop depreciating the research facility eve if they will not have recovered their $50,000,000. Therefore, it makes some sense that ABC is trying to recover the same money in the same period. In this case, and most important, ABC owns the facility- ownership being a key factor in the question of depreciation (Internal Revenue Service, 2014). However, the decision is not as simple as that.
For example, the facility is a nonresidential property. For such property, the depreciation is to be done over a period of 39 years. ABC, unfortunately, does not have 39 years. The property will be of no value in just 5 years. In typical situations (say the facility would be of value to ABC for the next 39 years or more), a straight-line method would be used. In this regard, an equal amount would be depreciated every year for the next 39 years and/or until the asset is fully depreciated. On the same note, there are a number of strategies by which to obtain the highest amount of depreciation. One such strategy that could work for ABC would be to apportion as much of the facility’s purchase price as possible to improvement and the littlest to land (considering that land does not depreciate). This may be done by using the same proportion of land-to-value that the assessor uses. If the assessor can find that 95 percent of the property’s value can be attributed to improvements and just 5 percent on land, ABC can use this appointment. It should be noted that, although this may be a true reflection of the distribution, the IRS are generally expected to accept the assessor’s valuation (Financial Web, 2015).
The most common tool used to depreciate properties (and which ABC could also use) is the Modified Accelerated Cost Recovery System (popular as MACRS). ABC’s research facility meets all the requirements for inclusion. It was placed in service in 2011 (after 1987), it is a tangible property and was acquired on a taxable transfer (Internal Revenue Service, 2014).
However, another factor that stands in the way of ABC’s plans for depreciation is the evolution of tax legislation(s) over the years. The Tax Reform Act of 1986, for instance, limited the capacity of such property to act as tax shelters for the owners. With this legislation, real estate losses are since considered passive losses and are, therefore, not actively involved the valuation of taxation. Such passive losses can now only be used to offset what has come to be known as passive income. For example, whatever loss ABC suffers in the research facility can only offset the same value in another property that would otherwise be a taxable income. The same legislation has also since limited the ability of taxpayers (ABC) to shelter active income with passive losses.
There are generally two possible outcomes. The first is that ABC has a lesser chance of getting their way; that is, a 30 percent probability that the court will sustain its position. In such a situation, the court will demand full disclosure of the company’s financial position as well as the other circumstances surrounding this situation.
Indeed, disclosure is another area that complicates depreciation. Through legislations like FIN 48, new financial rules require full disclosure on the part of companies. FIN 48 (replacing FABS) looked to avoid the feared potential for organizations to use the lack of certainty in measuring tax contingencies as a way to avoid taxes (Schneider, 2007; Kapur, 2013). Generally, accumulated allowances for depreciation and depletion as well as asset valuation allowances for losses (including receivables and investments) should be subtracted from the assets to which they relate. However, there are circumstances when such allowance may appear as liabilities or anywhere on the balance sheet’s credit side. However, the board directs that even in such circumstances, appropriate disclosure must be made.
It has become a general practice that the disclosure of the total value of depreciation expense becomes part of the determination of operations results. Organizations are also expected to disclose the balances of major depreciable asset classes. However, practices relating to the disclosure of the methods(s) used vary.
Generally, the assessment of depreciation, as well as the amount charged for it in the depreciation period focuses on three issues. The first is the historical costs or other amount that has stood in the place of the historical cost of the depreciable assets in the previous times when the assets has been revalued. This refers to the money outlay in relation to the asset’s acquisition, installations and commissioning. The second factor is the depreciable asset’s expected useful life. These should be predetermined by both contractual and legal limits (including expiry date of the usefulness). Finally, the third factor is the depreciable asset’s estimated residual value (Accounting Standards, n.d.; APB 12: Omnibus Opinion, 1967). All these are issues that must be taken into consideration and clearly documented. In the end, depreciation method(s) has/have significant impacts on financial position and outcomes of operations. Therefore, full disclosure should cover the following:
The depreciation expense for that period
The balances of major depreciable assets classes at the balance-sheet date (including nature and function)
Accumulated depreciation at the balance sheet data (including depreciable assets or in total), and
The general description of the method(s) used to compute depreciation in relation to major depreciable asset classes.
If ABC has a higher (such as 70 percent) probability of having their way, there are a few things that are likely to change. For example, such a decision would be against the norms of the law, such as the 39-year depreciation period. In such a situation, therefore, ABC would need to also disclose the depreciation rates and/or the asset’s useful lives. Equally, accepting ABC’s move would mean a revaluing of the research facility for purposes of taxation. In such a case, the provision of depreciation would use the new value. Moreover, if the revaluing should have a material impact on the amount of depreciation, this would have to be disclosed separately in the same year of reevaluation.
Accounting Standard (AS). Retrieved 30
March 2015, http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175820900634&blobheader=application/pdf&blobcol=urldata&blobtable=MungoBlobs
APB 12: Omnibus Opinion – 1967. Retrieved 30 March
Carmichael, D.R. & Graham, L. (2009). Accountants Handbook, 2009 Cumulative
Supplement. 11th Edition.
Financial Web (2015). Real Estate Depreciation and Tax Sheltering. Retrieved 29 March
Internal Revenue Service (2014). How to Depreciate Property. Department of the
Treasury, Publication 946, Cat. No. 13081F. Retrieved 29 March 2015, http://www.irs.gov/pub/irs-pdf/p946.pdf
Kapur, S.K. (2013). FIN 48 is no Fun for Brazilian Companies with Uncertain Tax
Positions. Retrieved 30 March 2015, http://issuu.com/revistacomercialista/docs/comercialista_v.9_-_m_a#
Price Waterhouse Coopers (2012). IFRS Disclosure Checklist. Retrieved 30
Schneider, S.R. (2007). Tax Management. Tax Management Memorandum, 48(8), 1-8
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