Taylor Corporation purchased a new asset for $80,000. The asset had an estimated life of 5 years and an estimated salvage value of $20,000. Now suppose that instead of using a life of five years, the company used an estimated life of ten years and a salvage value of $20,000. What is the effect on income in the second year, assuming straight-line method and a tax rate of 30%?

A. $12,000
B. $6,000
C. $4,200

Correct Answer: C

If the life is extended to 10 years, the depreciation expense for each of the ten years would be $6,000 [($80,000-$20,000)/10]. The effect on the first five years' income before taxes would be $6,000 ($12,000 - $6,000). The after-tax effect on income would be $4,200 ($6,000 x .7). For the first five years, income would be greater by $4,200. For the next five years, income would be less by that amount (assuming no changes in the tax rate). The advantage to the company would be that more income could be recognized earlier by using a longer period, and the company could probably replace the asset during the last five years and not have to recognize the depreciation expense.