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CCA

# CCA

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10/07/2012

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Wali Memon

Important Terms
(CCA) Capital gain Capital loss Cash flow from operations Cash flow statement CCA recapture Depreciation
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Wali Memon

Generally accepted accounting principles (GAAP) Half-year rule Operating loss Terminal loss Undepreciated capital cost (UCC)

CCA

(CCA) is the ‘depreciation’ method used by taxpayers in Canada when reporting business income to CRA Canada Revenue Agency for tax purposes.

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Wali Memon

Importance of CCA to Financial Decisions

Taxation issues must be explicitly addressed in each financial decision you make. Since CCA affects the net income from a business (and especially affects net cash flow), knowledge of the CCA system is essential for all business decision-makers.

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Wali Memon

CCA gives rise to a ‘Tax Shield Benefit’ to the Company
CCA is a non-cash deduction from income that would otherwise be subject to income taxation. As a result of the CCA deduction, taxable income is reduced. This results in a savings in tax payable. The tax shield benefits is equal to: T(CCA)

t = corporate tax rate CCA = the dollar amount of CCA claimed
A firm with a 40% corporate tax rate and a \$2,000 CCA deduction will save \$800 in taxes.
Tax Savings on CCA = Corporate Tax Rate × CCA = 40% × \$2,000 = \$800

Example:
Consider two firms that report \$10,000 in earnings before CCA and taxes, face a 40% tax rate. One firm has no CCA to claim, the other can claim \$2,000 in CCA

Company A
Earnings Before CCA & Tax CCA Taxable Income Taxes @ 40% Net Income Add back non-cash expense Cash flow from Operations 6,000 \$10,000 2,000 \$ 8,000 3,200 \$ 4,800 2,000

Company B
\$10,000 0 \$ 10,000 4,000 \$ 6,000 0 \$ 6,800 \$

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Note that company A is better off by \$800 because of the \$2,000 non-cash deduction of CCA. That is the amount of taxes saved.
Wali Memon

If you look at net income, Company A appears to be worse off, however, that is only an accounting illusion!!

CCA vs. Accounting Depreciation
CCA
like assets are grouped into pools or classes the CCA rate used in each asset class is setout in the regulations to the Income Tax Act and may or may not reflect economic wastage of the asset no estimate of useful life or of salvage value as long as the firm remains in existence, and assets remain in the pool, residual UCC values will remain in the pool.

Accounting Depreciation
choose the method that will best represent the economic wastage of the asset (declining balance, sum-of-the-year’s digits, straight-line, etc.) individual assets are depreciated estimate of useful life and salvage value is included

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Wali Memon

CCA Rules

1/2 of the regular CCA rate for the class applies to the net additions to the pool for that year. CCA cannot be used to create a tax loss.

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CCA Over Time - A Simple Example
Assume you acquire a depreciable asset with a cost base of \$100,000 and there are no other assets in this pool. The CCA rate for the pool is 10%. Note you are allowed only 1/2 the regular CCA rate on the net additions to the pool in the year of acquisition.

Year 1 2 3 4 etc.

UCC of pool 0 95000 85500 76950

Addition CCA @ 10% 100000 5000 0 9500 0 8550 0 7695

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Wali Memon

CCA Tax Shield Over Time
(Assume a corporate Tax Rate ‘T’ of 40%)

Year 1 2 3 4 5 6 7 8 9
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UCC of pool 0 95,000 85,500 76,950 69,255 62,330 56,097 50,487 45,438

Addition CCA @ 10% T(CCA) 100,000 5,000 2,000 0 9,500 3,800 0 8,550 3,420 0 7,695 3,078 0 6,926 2,770 0 6,233 2,493 0 5,610 2,244 0 5,049 2,019 0 4,544 1,818

Tax Shield Over Time
(A Graphical Representation)

T(CCA) at 10% on \$100,000
4000 3500 3000 2500 Tax Shield 2000 1500 1000 500 0 1
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Asymptotic Curve

3

5

7

9 11 13 15 17 19 Year

Wali Memon

Observations
In the foregoing you can now readily see:
CCA provides large tax shields in the early years of the asset’s life residual values remain in the pool long after the asset was acquired…this means that the firm will never fully recoup the original cost of the asset … as the firm’s asset base ages, cash flows generated from CCA will not enable the firm to replace the original asset.

If a capital intensive firm were to pay out all of its earnings in the form of dividends, there would not be sufficient cash flow left to replenish the asset base that is wearing out… eventually the firm would go out of business … its physical assets would be worthless and UCC would remain on it’s books!
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Wali Memon

Disposition of Assets and CCA

A taxable capital gain would occur if the firm sold a depreciable asset for greater than it’s original cost.

Capital Gain = Original Cost Base - Salvage Value

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Wali Memon

Disposition of Assets and CCA

If the salvage value of the asset exceeds the UCC of the pool there is a recapture of depreciation recaptured depreciation is subject to tax
Recaptured Depreciation = UCCpool - Salvage Value

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Wali Memon

Disposition of Assets and CCA

When the last physical asset in the pool is sold and not replaced, the pool will be closed out. If there is a positive balance remaining in the pool after disposition, that balance is called a terminal loss and is deductible from income in that year….it is a non-cash deduction just like CCA.

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CRA Form

1 Class number

2 Undepreciated capital cost (UCC) at the start of the year

3 Cost of additions in the year

4 Proceeds of dispositions in the year

6 5 7 UCC Adjustments for Base amount after additions current year for capital and additions (1/2 cost dispositions times (col. 3 allow ance (col. 2 plus 3 minues 4)) If (col. 5 minus minus 4) negative, enter 6)

8 Rate %

9 CCA for the year (col. 7 times 8 or an adjusted amount)

10 UCC at the end of the year (col. 5 minus 9)

6 6

91,874.00 32,880.00 25,000.00 90,172.60 11,900.00 54,008.00

99,754.00 48,064.60

3,940.00 0.00

95,814.00 48,064.60

0.1 0.1

9,581.40 4,806.46 14,387.86 3,596.97

90,172.60 43,258.14

TOTAL CCA = TAX SAVINGS =

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Wali Memon

- Depreciation for tax purposes

Class
1 8 10 13 16 22 43

Rate
4% 20% 30% Straight-line 40% 50% 30%

Assets
Buildings acquired after 1987 Furniture, photocopiers Vans, trucks, tractors and computers Leasehold improvements Taxicabs and rental cars Pollution control equipment Manufacturing equipment

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Wali Memon

CCA Schedule (simple)

1 Class number

2 Undepreciated capital cost (UCC) at the start of the year

3 Cost of additions in the year

4 Proceeds of dispositions in the year (Use the low er of Original cost or selling price)

6 5 7 Adjustments for Base amount UCC af ter additions current year for capital cost and additions (1/2 allow ance dispositions times (col. 3 (col. 5 minus (col. 2 plus 3 minues 4)) If 6) minus 4) negative, enter "0"

8 Rate %

9 CCA for the year (col. 7 times 8 or an adjusted amount)

10 UCC at the end of the year (col. 5 minus 9)

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10,000.00

0.00

0.00

10,000.00

0.00

10,000.00

0.1

1,000.00

9,000.00

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Wali Memon

CCA Schedule (simple over time)

1 Class number

2 Undepreciated capital cost (UCC) at the start of the year

3 Cost of additions in the year

6 4 5 7 Adjustments for Base amount Proceeds of UCC dispositions in after additions current year for capital cost additions (1/2 the year (Use and allow ance the low er of dispositions times (col. 3 (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0"

8 Rate %

9 CCA for the year (col. 7 times 8 or an adjusted amount)

10 UCC at the end of the year (col. 5 minus 9)

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10,000.00 9,000.00 8,100.00 7,290.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

10,000.00 9,000.00 8,100.00 7,290.00

0.00 0.00 0.00 0.00

10,000.00 9,000.00 8,100.00 7,290.00

0.1 0.1 0.1 0.1

1,000.00 900.00 810.00 729.00

9,000.00 8,100.00 7,290.00 6,561.00

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Wali Memon

CCA Schedule (simple – ½ net additions rule)
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 6 5 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions additions (1/2 the year (Use and allow ance dispositions times (col. 3 the low er of (col. 5 minus minues 4)) If Original cost (col. 2 plus 3 6) minus 4) negative, enter or selling price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

0.00 19,000.00 17,100.00

20,000.00 0.00 0.00

0.00 0.00 0.00

20,000.00 19,000.00 17,100.00

10,000.00 0.00 0.00

10,000.00 19,000.00 17,100.00

0.1 0.1 0.1

1,000.00 1,900.00 1,710.00

19,000.00 17,100.00 15,390.00

The ‘bottom line’ here is that you are allowed only half the regular CCA on additions to the pool in the year of acquisition.
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Wali Memon

CCA Schedule (simple – ½ net additions rule)
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 6 5 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions additions (1/2 the year (Use and allow ance dispositions times (col. 3 the low er of (col. 5 minus minues 4)) If Original cost (col. 2 plus 3 6) minus 4) negative, enter or selling price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

0.00 9,500.00 8,550.00

20,000.00 0.00 0.00

10,000.00 0.00 0.00

10,000.00 9,500.00 8,550.00

5,000.00 0.00 0.00

5,000.00 9,500.00 8,550.00

0.1 0.1 0.1

500.00 950.00 855.00

9,500.00 8,550.00 7,695.00

A ‘net addition’ to the pool is equal to additions minus disposals.
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Wali Memon

CCA Schedule (simple – changes over time)
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 6 5 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions additions (1/2 the year (Use and allow ance dispositions times (col. 3 the low er of (col. 5 minus minues 4)) If Original cost (col. 2 plus 3 6) minus 4) negative, enter or selling price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

10,000.00 9,000.00 8,100.00

0.00 0.00 0.00

0.00 0.00 0.00

10,000.00 9,000.00 8,100.00

0.00 0.00 0.00

10,000.00 9,000.00 8,100.00

0.1 0.1 0.1

1,000.00 900.00 810.00

9,000.00 8,100.00 7,290.00

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Wali Memon

CCA Schedule (simple – changes over time)
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance times (col. 3 the low er of dispositions (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

0.00 9,500.00 8,550.00

10,000.00 0.00 0.00

0.00 0.00 0.00

10,000.00 9,500.00 8,550.00

5,000.00 0.00 0.00

5,000.00 9,500.00 8,550.00

0.1 0.1 0.1

500.00 950.00 855.00

9,500.00 8,550.00 7,695.00

Compare this slide with the last one…note that the CCA in the first year is half as great as in the last slide…because there was a net addition to the pool of \$10,000 and no beginning UCC. 23
Wali Memon

CCA Schedule (Disposals)
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance dispositions times (col. 3 the low er of (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

0.00 9,500.00 8,550.00

10,000.00 0.00 0.00

0.00 0.00 5,000.00

10,000.00 9,500.00 3,550.00

5,000.00 0.00 0.00

5,000.00 9,500.00 3,550.00

0.1 0.1 0.1

500.00 950.00 355.00

9,500.00 8,550.00 3,195.00

When you dispose of assets from the pool remember…that you are not allowed ANY CCA on the asset that has been disposed of even though you might have used the asset for the greater part of the fiscal year.
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Wali Memon

CCA Schedule – changes over time
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 6 5 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions additions (1/2 the year (Use and allow ance dispositions times (col. 3 the low er of (col. 5 minus minues 4)) If Original cost (col. 2 plus 3 6) minus 4) negative, enter or selling price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

0.00 24,225.00 27,502.50

25,500.00 10,000.00 0.00

0.00 4,000.00 2,000.00

25,500.00 30,225.00 25,502.50

12,750.00 3,000.00 0.00

12,750.00 27,225.00 25,502.50

0.1 0.1 0.1

1,275.00 2,722.50 2,550.25

24,225.00 27,502.50 22,952.25

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Wali Memon

CCA Schedule – Recapture
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance times (col. 3 the low er of dispositions (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

0.00 24,225.00 27,502.50

25,500.00 10,000.00 0.00

0.00 4,000.00 30,000.00

25,500.00 30,225.00 -2,497.50

12,750.00 3,000.00 0.00

12,750.00 27,225.00 0.00

0.1 0.1 0.1

1,275.00 2,722.50 0.00

24,225.00 27,502.50 -2,497.50

If the proceeds on the sale of an asset in the pool cause the balance in the pool to become negative…that negative amount is a recapture of depreciation.
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Wali Memon

Recapture of Depreciation
A recapture is ‘realized’ on the disposal of an asset in a CCA pool where the remaining balance in the pool turns negative….essentially this arises because the government has allowed you to depreciate for tax purposes the equipment at too great a rate. When you sold the equipment…the selling price did not reflect the ‘depreciated value’…the selling price exceeded not only the depreciated value of the individual asset…but if other assets remain in the pool, the selling price has exceeded the depreciated (or UCC) of all of the assets remaining in the pool. You will have to claim the recapture as income in the fiscal year that it was realized…and pay income taxes on it.
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Wali Memon

CCA Schedule – Terminal Loss
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance times (col. 3 the low er of dispositions (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

10,000.00 0.00 0.00

0.00 0.00 0.00

5,000.00 0.00 0.00

5,000.00 0.00 0.00

0.00 0.00 0.00

5,000.00 0.00 0.00

0.1 0.1 0.1

500.00 0.00 0.00

4,500.00 0.00 0.00

If the LAST physical asset in the asset class was finally sold for \$5,000, and \$4,250 was left in the pool…the \$4,250 is a ‘terminal loss’.
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Wali Memon

Terminal Losses are Rare

These are usually pretty rare in practice…because, generally when old assets are worn out…they are replaced…and therefore, there remain physical assets in the pool. Only if a firm is getting out of a line of business…and disposing of all of their assets (or perhaps deciding to lease them all instead of owning them)…can you imagine a firm disposing of all of the assets in an asset pool.

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Wali Memon

Tax Treatment of Terminal Losses

In essence, a residual value left in the pool after the sale of the last physical asset…can only occur if the sale value of the assets (disposal values) were less than the UCC of the assets…this means that over time, the government’s CCA rate did not reflect the true ‘wastage’ of the assets. Consequently, a terminal loss can be deducted from income (just like regular CCA) Since a terminal loss is a non-cash deduction (like CCA) it will give rise to a tax shield (Tax shield = terminal loss times the corporate tax rate)
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Wali Memon

CCA Schedule – Capital Gain
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance times (col. 3 the low er of dispositions (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

40,000.00 36,000.00 32,400.00

0.00 0.00 0.00

0.00 0.00 16,500.00

40,000.00 36,000.00 15,900.00

0.00 0.00 0.00

40,000.00 36,000.00 15,900.00

0.1 0.1 0.1

4,000.00 3,600.00 1,590.00

36,000.00 32,400.00 14,310.00

You sell an asset for \$20,000 that originally cost you \$16,500, you would use the lower of the two values to record this disposal for CCA purposes.
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Wali Memon

CCA Schedule – Capital Gain and a Recapture
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance dispositions times (col. 3 the low er of (col. 5 minus (col. 2 plus 3 minues 4)) If Original cost 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

6 6 6

16,500.00 14,850.00 13,365.00

0.00 0.00 0.00

0.00 0.00 16,500.00

16,500.00 14,850.00 -3,135.00

0.00 0.00 0.00

16,500.00 14,850.00 0.00

0.1 0.1 0.1

1,650.00 1,485.00 0.00

14,850.00 13,365.00 -3,135.00

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You sell an asset for \$20,000 that originally cost you \$16,500, you would use the lower of the two values to record this disposal for CCA purposes. If the sale causes the UCC to become negative…a recapture of depreciation will also be triggered by the transaction.
Wali Memon

CCA Schedule template
1 Class number 2 Undepreciated capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 6 7 4 Adjustments for Base amount Proceeds of UCC current year for capital cost dispositions in af ter additions the year (Use and additions (1/2 allow ance times (col. 3 the low er of dispositions (col. 5 minus Original cost (col. 2 plus 3 minues 4)) If 6) or selling minus 4) negative, enter price) "0" 8 Rate % 9 10 CCA UCC at the end for the year of the year (col. 7 times (col. 5 minus 8 or an 9) adjusted amount)

Year 20XX 20X1 20X2

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Wali Memon

Capital Gains and CCA

If you sell a depreciable asset for more than it’s original cost…then the difference is a realized capital gain: Capital Gain = Selling Price – Original Cost \$3,500 = \$20,000 - \$16,500

You would use the lower of the Original cost or the selling price when recording the asset disposal for CCA purposes…. (in this case \$16,500)

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Finding Ending UCC

You can always do a detailed table to finding ending UCC given the assumption of maximum use of available CCA in each year… However, you can also use a formula:

r UCCn = C0 (1 − )(1 − r ) n −1 2 .1 UCC5 = \$100,000(1 − )(1 − .1) 5−1 2 UCC5 = \$100,000(.95)(.9 4 )
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UCC5 = \$100,000(.95)(.6561) UCC5 = \$62,329.50

Finding ending CCA using a full CCA Schedule
1 2 Class Undepreciated number capital cost (UCC) at the start of the year 3 Cost of additions in the year 5 4 6 7 Base Proceeds of UCC Adjustments for amount for dispositions in after additions current year capital cost the year (Use and additions (1/2 allow ance (col. the low er of dispositions times (col. 3 5 minus 6) Original cost (col. 2 plus 3 minues 4)) If or selling minus 4) negative, enter 8 Rate % 9 CCA 10 for the year UCC at the end (col. 7 times 8 of the year or an adjusted (col. 5 minus 9) amount)

6

0.00 95,000.00 85,500.00 76,950.00 69,255.00

100,000.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00

100,000.00 95,000.00 85,500.00 76,950.00 69,255.00

50,000.00 0.00 0.00 0.00 0.00

50,000.00 95,000.00 85,500.00 76,950.00 69,255.00

0.1 0.1 0.1 0.1 0.1

5,000.00 9,500.00 8,550.00 7,695.00 6,925.50

95,000.00 85,500.00 76,950.00 69,255.00 62,329.50

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Wali Memon

CCA and Capital Budgeting
Since the tax shield on CCA varies over time and the stream of tax shield benefits can go on forever, it is necessary to develop an equation for the tax shield on CCA
Present Value of Tax Savings on CCA :  C Td  1 + .5k  =  0 ×   k + d   1+ k 

This equation assumes the asset is purchased and held forever (there is no salvage value)…that the maximum CCA is claimed each year

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