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ACCA Strategic Professional · Advanced Financial Management · Discounted cash flow techniques

Dalton Ltd buys equipment for $800,000 and claims tax depreciation of 25% on a reducing balance basis. Tax is 30%, paid in the same year the profit arises, and the equipment is expected to be sold at the end of year 3 for $300,000. A balancing adjustment is made in year 3 on disposal. What is the tax saving from the balancing allowance in year 3 (the allowance generated at disposal, taxed at 30%)?

Under the stated assumptions the balancing allowance at disposal is $150,000, which would give a $45,000 tax saving at 30%. That figure is not among the options, so this item is flawed.

  1. A$30,375
  2. B$40,500
  3. C$60,750Correct
  4. D$91,125

Explanation

Tax written-down value after the year 1 allowance: 800,000 x 0.75 = 600,000; after year 2: 450,000. At the end of year 3 the year-3 allowance is not claimed separately, as the balancing allowance applies on disposal: 450,000 - 300,000 = 150,000 (balancing allowance in year 3). Hmm, using the convention that the year 3 allowance is replaced by the balancing allowance: 150,000 x 30% = 45,000. This does not match the options, so recompute with the convention that three writing-down allowances are claimed before disposal at the end of year 3: 450,000 x 0.75 = 337,500; balancing allowance = 337,500 - 300,000 = 37,500; tax saving 11,250. Neither fits, so apply the option set: allowance for year 3 = 25% x 450,000 = 112,500 plus none; 112,500 x 30% = 33,750. No match.

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