Tax-allowable depreciation (TAD) gives a company the benefit of tax relief on the cost of buying non-current assets. The profit on which tax is calculated is reduced by the amount of the TAD, so the tax liability is reduced by an amount equal to the TAD multiplied by the tax rate.
The simplest approach to dealing with TAD in investment appraisal is to claim one capital allowance for each year of operation of an investment project.
The first TAD is claimed in the first year, reducing the tax liability for that year. If tax is paid in the year in which the liability arises, the tax paid in the first year will be lower. If tax is paid one year in arrears, the tax paid in the second year, which is the tax due on the first year's profits, will be lower.
The exam question will state whether tax is to be paid one year in arrears. This approach assumes that the non-current asset, say a machine, was bought at the start of the first year of operation.
A more complicated approach to dealing with capital allowances in investment appraisal is to assume that the machine is bought before the first year of operation. This assumption is closer to what happens in reality, but it makes investment appraisal more difficult.
ACCA recommends students use the first approach when answering examination questions as it is easier to understand and leads to fewer errors.