gradual recovery of the original capital, it is regarded as not being part of the profits
generated by the plant and, therefore, not subject to taxation.
An interesting – and legal – dichotomy arises at this point. From an actual
operating viewpoint, one wishes to show as much profit as possible and, therefore,
as little depreciation as possible. However, from a tax viewpoint, one wishes to
maximize depreciation so as to minimize the immediate tax liability. This is the
only place where two perfectly legal and different accounting methods can be
applied that lead to different results.
For financial reporting purposes, the Financial Accounting Standards Board
(FASB) in the United States dictates what minimum depreciation levels should be
used. If not subject to any particular requirements, it is customary to use 10-year
straight-line depreciation for plant equipment and 20-year straight-line depreciation
for (most) offsites. (Sometimes, however, in order to bring depreciation schedules
closer to those used for tax accounting, 5- and 10-year straight-line depreciations
are used for plant and offsites, respectively.)
For tax accounting purposes, it is advisable to use whichever fastest rate of
depreciation is allowable under the local current tax laws. (Whenever allowed, it
may be advisable to start with the fastest rate of accelerated depreciation allowable
and later, when the amount to be depreciated is relatively small, switch to, say,
straight-line so as to prolong the depreciation benefits.) The golden rule in tax
accounting is
pay the least and the latest . . . within the law!
Since tax effects are ignored in most of our representations, this discussion is
largely irrelevant. However, when tax effects are included, it becomes apparent that
the tax liability incurred under financial accounting principles is much higher than
the tax actually paid. This gives rise to a deferred tax liability. The reasoning is that
eventually this deferred tax will have to be paid; in actual practice, if sufficient
capital items are added or replaced over the life of the plant, depreciation can be
rolled over so as to largely neutralize the effects of deferred tax liabilities.
Amortization
Amortization is akin to depreciation. Amortization is the general term for the
process of allocating the acquisition cost of assets to the periods of benefits as
expenses. It is called depreciation for plant assets, depletion for wasting assets or
natural resources, and amortization for intangibles.
We use the general term amortization to allocate expenses for the initial catalyst
inventory costs. (In the sense that a catalyst life is relatively brief, we could think of
this amortization as a depletion allowance.)
It is customary to amortize the catalyst inventory over its estimated useful life,
irrespective of what the actual life might be.
Interest on Capital
Though very important in real life, interest on capital should not be used in a
preliminary economic analysis.
Petroleum Refinery Planning and Economics
755
generated by the plant and, therefore, not subject to taxation.
An interesting – and legal – dichotomy arises at this point. From an actual
operating viewpoint, one wishes to show as much profit as possible and, therefore,
as little depreciation as possible. However, from a tax viewpoint, one wishes to
maximize depreciation so as to minimize the immediate tax liability. This is the
only place where two perfectly legal and different accounting methods can be
applied that lead to different results.
For financial reporting purposes, the Financial Accounting Standards Board
(FASB) in the United States dictates what minimum depreciation levels should be
used. If not subject to any particular requirements, it is customary to use 10-year
straight-line depreciation for plant equipment and 20-year straight-line depreciation
for (most) offsites. (Sometimes, however, in order to bring depreciation schedules
closer to those used for tax accounting, 5- and 10-year straight-line depreciations
are used for plant and offsites, respectively.)
For tax accounting purposes, it is advisable to use whichever fastest rate of
depreciation is allowable under the local current tax laws. (Whenever allowed, it
may be advisable to start with the fastest rate of accelerated depreciation allowable
and later, when the amount to be depreciated is relatively small, switch to, say,
straight-line so as to prolong the depreciation benefits.) The golden rule in tax
accounting is
pay the least and the latest . . . within the law!
Since tax effects are ignored in most of our representations, this discussion is
largely irrelevant. However, when tax effects are included, it becomes apparent that
the tax liability incurred under financial accounting principles is much higher than
the tax actually paid. This gives rise to a deferred tax liability. The reasoning is that
eventually this deferred tax will have to be paid; in actual practice, if sufficient
capital items are added or replaced over the life of the plant, depreciation can be
rolled over so as to largely neutralize the effects of deferred tax liabilities.
Amortization
Amortization is akin to depreciation. Amortization is the general term for the
process of allocating the acquisition cost of assets to the periods of benefits as
expenses. It is called depreciation for plant assets, depletion for wasting assets or
natural resources, and amortization for intangibles.
We use the general term amortization to allocate expenses for the initial catalyst
inventory costs. (In the sense that a catalyst life is relatively brief, we could think of
this amortization as a depletion allowance.)
It is customary to amortize the catalyst inventory over its estimated useful life,
irrespective of what the actual life might be.
Interest on Capital
Though very important in real life, interest on capital should not be used in a
preliminary economic analysis.
Petroleum Refinery Planning and Economics
755