Depreciation for tax purposes and book purposes are often different because you have opposite goals. In the tax world, the goal is usually to arrive at lowest net income possible in order to reduce the current year income tax expense. How do companies reduce net income? Increase expenses. One way to do this is through accelerated depreciation.
Here's a very crude and simplified example with numbers I completely pulled out of thin air:
Company has $100,000 of revenue and purchases a $50,000 piece of equipment (depreciable life of 5 years).
For book purposes, net income in year 1 is computed as follows:
Revenue: $100,000
Expense: (10,000)
Net Income: $ 90,000
However, for tax purposes, let's assume the MACRS depreciation is $20,000. ($10,000 greater than book depreciation). Net taxable income is computed as follows:
Revenue: $100,000
Expense: (20,000)
Net Income: $ 80,000
If you're going from book to tax, and you know the tax depreciation is greater/accelerated, than you must subtract the excess tax depreciation ($10,000) to arrive at your net taxable income. Why? When you computed your net income per books, you didn't have the accelerated depreciation in the computation, so your net book income must be reduced to take into consideration the accelerated depreciation for tax purposes.
Depreciation is just a recovery of cost over the life of an asset. Therefore, if your tax depreciation is accelerated up front, then there will be less (or nothing) to recover/depreciate in the future years for tax purposes, which results in the excess book depreciation you mentioned in the 2nd part of your question.
Back to our example, let's jump to year 5:
For book purposes, net income is the same as in year 1, computed as follows:
Revenue: $100,000
Expense: (10,000) — same as year 1
Net Income: $ 90,000
However, for tax purposes, let's assume the MACRS depreciation is only $5,000 in the final year (it's already been recovered/accelerated in earlier years).
Revenue: $100,000
Expense: ( 5,000)
Net Income: $ 95,000
Therefore, if you're going from book to tax, and you know excess book depreciation exists, than you must add the excess book depreciation ($5,000) to arrive at your net taxable income. Why? When computing your net income per books, you had additional/excess depreciation in the computation, so your net book income must be increased to take into consideration the excess depreciation that doesn't exist in the current year for tax purposes.
Summary:
When excess tax depreciation exists, your net taxable income should be lower than net book income, so a subtraction is necessary to arrive at net taxable income.
When excess book depreciation exists, your net taxable income should be higher than net book income, so an addition is necessary to arrive at net taxable income.
FAR 90 Oct. 6, 2012
AUD 96 Dec. 8, 2012
REG 93 May 30, 2013
BEC 84 Aug. 31, 2013
NIU CPA Review Correspondence and Wiley Test Bank
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