Chapter 5: Depreciation and Taxation

Question 1

1. What is depreciation?

Answer 1

Depreciation is the gradual reduction in the value of a tangible asset over time due to wear and tear or obsolescence. For example, a delivery truck loses value each year as it is used.

Question 2

2. Why is depreciation important?

Answer 2

Depreciation helps businesses account for the cost of using an asset over its useful life. It also reduces taxable income, as depreciation is treated as an expense. For instance, a business can deduct the annual depreciation of equipment from its income.

Question 3

3. What are the common methods of depreciation?

Answer 3

• Straight-line depreciation: Spreads the cost of an asset evenly over its useful life.
• Declining balance: Deducts a higher amount in the early years of an asset’s life.
  For example, if a $10,000 machine has a useful life of 5 years, its straight-line depreciation would be $2,000 per year.

Question 4

4. What is amortization?

Answer 4

Amortization is similar to depreciation but applies to intangible assets like patents or copyrights. For example, if a company spends $10,000 on a patent with a 10-year lifespan, it can amortize $1,000 annually.

Question 5

5. What is taxation?

Answer 5

Taxation is the process where governments collect money from individuals and businesses to fund public services. Examples include income tax, sales tax, and property tax.

Question 6

6. What is payroll tax?

Answer 6

Payroll tax is a tax paid by employers and employees on wages. It includes contributions to programs like Social Security and Medicare. For example, an employer might deduct a portion of an employee’s paycheck for these taxes and also contribute an additional amount.

Question 7

7. What is goodwill?

Answer 7

Goodwill is the value of a business’s reputation, customer base, or brand recognition. It’s recorded as an intangible asset during acquisitions. For example, if a company buys another business for more than its asset value, the extra amount is goodwill.

Question 8

8. What is leverage?

Answer 8

Leverage is the use of borrowed funds to finance investments or operations. It can amplify returns but also increases risk. For instance, if a company uses a loan to buy equipment that boosts production, the profit may outweigh the loan cost, creating positive leverage.

Question 9

9. What is a capital expenditure?

Answer 9

A capital expenditure (CapEx) is money spent to buy or improve long-term assets like buildings or equipment. For example, purchasing a new delivery truck is a capital expenditure because it provides long-term benefits.

Question 10

10. Why are depreciation and taxation important in accounting?

Answer 10

Depreciation and taxation affect a business’s financial health. Depreciation reduces taxable income, while proper tax planning ensures compliance and minimizes tax liabilities. For example, understanding these concepts helps a business invest in assets wisely and stay profitable.