Present Value Concepts
Hamburg Company recently began business and purchased a large facility to make beach
clothing. Hamburg Company managed to make a small profit in its initial year of operations,
although it used all its cash to purchase inventory and equipment. After preparing its tax return
for the year, Hamburg’s managers realized that they could pay less taxes than they
thought. Because IRS accelerated depreciation methods allow for higher depreciation expense
than the straight-line method the company is using for financial-reporting purposes,
Hamburg can claim more depreciation expense than it thought it could and can reduce taxable
income by $30,000. However, Hamburg’s managers know that the two depreciation
methods will eventually even out because the difference is only temporary and will create a
deferred income tax liability, which must be recorded on the books. The managers are very
conservative, though, and would rather pay the additional taxes now than record a liability
that must be paid in the future, even if they must borrow the money from a bank to pay the
extra taxes. They have come to you for advice. What would you tell them?