Healthcare Finance Chapter 1 Problem 5 Johnson Family Car
CT 1 Healthcare Financechapter 1 Problem 5johnson Family Care Inc Is
Johnson Family Care Inc. is a large ambulatory care center providing 24-hour primary and specialty care in Pennsylvania. The center recently purchased new clinical laboratory equipment for $1.1 million and spent $22,000 on renovations. The equipment has an estimated useful life of ten years and a salvage value of $75,000 at the end of its useful life. Johnson uses a straight-line method for book depreciation, and the company faces a tax rate of 40%. The equipment falls into the MACRS seven-year class.
Assignment tasks:
- Determine the annual depreciation expense reported on the income statement for the center.
- Calculate the annual depreciation expense for tax purposes.
- Analyze the tax implications if Johnson sells the laboratory equipment at the end of Year 4 for $400,000.
Paper For Above instruction
Depreciation accounting plays a crucial role in the financial management and tax planning of healthcare facilities such as Johnson Family Care Inc. Accurate depreciation methods impact reported income, taxable income, and cash flows. This paper explores the calculation of depreciation expenses using two different methods—straight-line for financial statements and MACRS for tax purposes—and analyzes the implications of asset sale on tax liabilities.
1. Book Depreciation Using Straight-Line Method
The straight-line depreciation method allocates the cost of an asset evenly over its estimated useful life. For Johnson Family Care, the initial cost of the equipment includes the purchase price plus renovation costs, totaling $1,122,000 ($1,100,000 + $22,000). Given a useful life of 10 years and a salvage value of $75,000, annual depreciation is calculated as:
\[
\text{Annual Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life}} = \frac{1,122,000 - 75,000}{10} = \frac{1,047,000}{10} = \$104,700
\]
Thus, Johnson Family Care reports $104,700 as depreciation expense annually on its income statement, reducing taxable income but not affecting cash flows directly.
2. Tax Depreciation Using MACRS
For tax purposes, the IRS recommends using Modified Accelerated Cost Recovery System (MACRS), which involves depreciation schedules that accelerate deductions in the early years of an asset's life. The equipment falls into the seven-year MACRS class, and the depreciation is computed based on IRS tables, which assign specific percentage rates to each year.
The MACRS depreciation schedule for seven-year property indicates the following approximate percentages:
- Year 1: 14.29%
- Year 2: 24.49%
- Year 3: 17.49%
- Year 4: 12.49%
- Year 5: 8.93%
- Year 6: 8.92%
- Year 7: 8.93%
- Year 8: 4.46%
Calculating the depreciation expense for Year 4:
\[
\text{Depreciation Year 4} = 1,122,000 \times 12.49\% \approx \$140,029.80
\]
Since MACRS typically doesn't consider salvage value, the full depreciation amount is deducted in each designated year, leading to higher depreciation expenses in the early years.
3. Tax Implications of Selling the Equipment at Year 4
When Johnson sells the laboratory equipment at the end of Year 4 for $400,000, the sale triggers tax consequences based on the difference between the sale price and the book value after accumulated depreciation.
The book value after three years, using straight-line depreciation, is:
\[
\text{Accumulated Depreciation} = 3 \times 104,700 = 314,100
\]
\[
\text{Book Value at Year 3} = 1,122,000 - 314,100 = \$807,900
\]
Using MACRS depreciation, the accumulated depreciation is the sum of depreciation for Years 1 to 3:
\[
14.29\% + 24.49\% + 17.49\% = 56.27\%
\]
\[
\text{Accumulated Depreciation} = 1,122,000 \times 56.27\% \approx \$631,679.40
\]
\[
\text{Book Value at Year 3} = 1,122,000 - 631,679.40 \approx \$490,320.60
\]
Assuming the MACRS schedule is used for tax purposes, the book value at the end of Year 4 can be approximated by subtracting Year 4 depreciation:
\[
\text{Book Value} = 490,320.60 - 140,029.80 \approx \$350,290.80
\]
The gain or loss on sale is:
\[
\text{Gain} = \text{Sale Price} - \text{Book Value} = 400,000 - 350,290.80 \approx \$49,709.20
\]
This gain is taxable, increasing Johnson’s taxable income and tax liability:
\[
\text{Tax on gain} = 49,709.20 \times 40\% \approx \$19,883.68
\]
Therefore, selling the equipment at Year 4 results in taxable gain, which increases tax payment by approximately $19,884. Johnson must account for this gain when preparing its tax return, possibly influencing decisions about asset disposal timings to optimize tax outcomes.
Conclusion
The depreciation expense reported on financial statements under the straight-line method is consistent annually at $104,700, providing simplicity and predictability. In contrast, MACRS accelerates depreciation, offering significant tax shields in initial years. When disposing of assets before the end of their depreciation schedule, companies face tax consequences arising from gains or losses on sale, which must be carefully managed to optimize tax efficiency. Understanding these depreciation methods and their implications is vital for healthcare organizations like Johnson Family Care Inc. in strategic financial planning and compliance with tax regulations.
References
- Internal Revenue Service. (2022). Publication 946: How To Depreciate Property. IRS.
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