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Why Teach Depreciation And Income Taxes?

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Conference

2004 Annual Conference

Location

Salt Lake City, Utah

Publication Date

June 20, 2004

Start Date

June 20, 2004

End Date

June 23, 2004

ISSN

2153-5965

Conference Session

Integrating Taxes, Law, & Business

Page Count

5

Page Numbers

9.1422.1 - 9.1422.5

Permanent URL

https://peer.asee.org/14110

Download Count

29

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Paper Authors

author page

William Sullivan

author page

Janis Terpenny

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Abstract
NOTE: The first page of text has been automatically extracted and included below in lieu of an abstract

Session 1339

Why Teach Depreciation and Income Taxes? William G. Sullivan1 and Janis P. Terpenny2 Virginia Polytechnic Institute and State University, Blacksburg, VA1/ University of Massachusetts, Amherst, MA2

Abstract

Often the best mutually exclusive alternative in a before-tax economy study is an inferior course of action in an after-tax study. Hence, we teach our students to include the effects of income taxes to avoid mis-allocating scarce capital. Despite this, our students who work in industry frequently perform only before-tax profitability studies and, as appropriate, leave the income tax intricacies to finance/accounting people. The purpose of this paper is to reinforce the necessity of after-tax economy studies in practice. An example is presented that illustrates four methods for taking income taxes into account. Two of the methods produce the correct rank ordering of projects while the remaining two do not. We recommend that an income tax specialist be consulted in practice when the projects under consideration are complicated with respect to their tax ramifications.

1. Introduction When deciding among mutually exclusive alternatives, managers as fiducial agents for a company’s owners are principally concerned with the after-tax profitability (present worth, annual worth, internal rate of return) of a capital investment. Income taxes are viewed as a normal expense incurred in generating income, and income is not as important as how much money is left after all expenses, including income taxes, are paid [4]. Because of this reality, we teach our students to present the after-tax consequences of competing projects in order to give managers a fair and complete picture of the after-tax profit potential of the feasible projects. Engineering students need to consider income taxes in their economy studies to ensure that they understand income tax trade-offs. For instance, students learn about capitalizing versus expensing a cost element, and this is important to understand when capital-intensive projects are compared with, for example, labor-intensive projects and leasing arrangements. If the effective income tax rate is 40%, students understand that an expensed investment (e.g., a machine overhaul) costs 60 cents on the dollar after taxes whereas a capitalized (depreciated) investment produces an after-tax benefit of 8 cents on the dollar with straight line depreciation over five years. Its after-tax cost is therefore 92 cents on the dollar, so students know to expense an item when it’s legal and appropriate. Despite our best efforts to teach the necessity for after-tax profitability studies, a large number of practicing engineers perform only before-tax studies and leave the income tax and financial details to other professionals (or are they ignored?). The aim of this paper is to reinforce the need for after-tax economic studies and to illustrate four popular methods for accomplishing this

Proceedings of the 2004 American Society for Engineering Education Annual Conference & Exposition Copyright © 2004, American Society for Engineering Education

Sullivan, W., & Terpenny, J. (2004, June), Why Teach Depreciation And Income Taxes? Paper presented at 2004 Annual Conference, Salt Lake City, Utah. https://peer.asee.org/14110

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