depreciation expense

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bmwhype

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if i increase depreciation expense by $10 and the tax rate is 40%, how does it flow through out the 3 main financial statements?

on the balance sheet
dep exp goes up by 10
tax takes out 4
net income is reduced by 6


cash flow statement
CFO goes down by 6
net CF goes down by 6


on the balance sheet
retained earnings goes down by 6
cash goes down by 6


am i completely correct?
 
You're right in concept but not COMPLETELY correct~~
as the first one should be INCOME STATEMENT~~~ =D

It is somehow hard to judge about CF, as it could have used different depreciation method in Tax return........... I know you meant it to be the same, but just bear in mind.
 
How would reducing your pre-tax income increase your tax burden? You might check your math.
 
i didnt say an increase of tax. that is just what tax takes out.
 
increase depreciation expense by $10
CFO goes down by 6

maybe i'm reading this wrong but bmw is saying that increased depreciation will decrease CFO?
 
I think he is, and that's not correct. But maybe I'm having a brain-fart this morning. On the cash flow statement:

Net income is lower by $6
Depreciation is higher by $10
Cash taxes (an outflow) are lower by $4

So the net effect on CFO is +8.
 
bmw, is correct, but is using a different "syntax" than what we're used to. He's coming at it from time 0, while usually accounting questions on exams (not just the CFA exam) come at it from a time 1/adjustment perspective. That's why some of you may be confused as I was when I first read the post.



Edited 1 time(s). Last edit at Friday, April 13, 2007 at 12:24PM by kkent.
 
alright... i thought you were agreeing with him "i'm with you" and then disagreeing w/ you next sentance.

i think the net effect on cash flow would just be due to the actual tax cash outflow difference... why are you adding the net income difference?
with depreciation, the money doesnt change hands when depreciation is booked for that period... yes? ummmmmmmmmm... maybe i'm getting things messed up in my head. but net cash flows arent all that influenceable by management like earnings/net income are.



Edited 1 time(s). Last edit at Friday, April 13, 2007 at 12:28PM by nolabird032.
 
I wouldn't get worked up over this question, fellas. You'll never EVER see a question like this--it'll be formatted differently and it'll make a lot more sense on the exam.
 
Here is the definitive answer:

Income Statement:

Depreciation expense up by $10
Tax Expense Down by $4
Net Income Down by $6


Balance Sheet (assume no deferred tax impact)

Cash up by $4 (tax savings)
PP&E down by $10
(net effect on assets is $6 decrease)

Retained earnings down by $6 from lower income, balance sheet balances

Cash Flow (indirect)

Net income down by $6
Depreciation addback is $10

Net effect is cash from ops is $4 higher which matches change on balance sheet



Edited 1 time(s). Last edit at Friday, April 13, 2007 at 12:39PM by Super I.
 
thanks Super... thats what i was trying to say in my wordy and unintelligible post.

what exactly do you do anyway? if you ever need to come up with a title... you should go with "FSA super hero"
 
Super I Wrote:
-------------------------------------------------------
> Here is the definitive answer:
>
> Income Statement:
>
> Depreciation expense up by $10
> Tax Expense Down by $4
> Net Income Down by $6
>
>
> Balance Sheet (assume no deferred tax impact)
>
> Cash up by $4 (tax savings)
> PP&E down by $10
> (net effect on assets is $6 decrease)
>
> Retained earnings down by $6 from lower income,
> balance sheet balances
>
> Cash Flow (indirect)
>
> Net income down by $6
> Depreciation addback is $10
>
> Net effect is cash from ops is $4 higher which
> matches change on balance sheet

thanks. this is an interview question for ibanking.
 
Give me the changes in each of the three financial statements when accrued liabilities increases by $10 and the tax rate is 40%.

IS- Expenses go up by 10, decreases EBIT by 10, gives a tax savings of 4 dollars but NI decreases by 6
BS- Liabilities increase by 10 and SE decreases by 6, Assets increase by 4 (A=L+SE 4=10+(-6))
CF- CFO goes up because of net increase of $4 in cash
 
how is accrued liabilities accounted for on the CF statement?
 
bmw, do you know what I'm at a complete loss for? How so many IBankers were liberal arts majors in school and yet a number of interviews require some fairly in-depth knowledge of financial statements, etc. I can only ASSUME that entry-level analyst positions don't ask those kinds of questions, only the experienced-level ones. Would that be correct?
 
well those people are very driven, given that they pay 120k for college. anyways, im interviewing for equity research within ibanking. totally different.
 
bmwhype Wrote:
-------------------------------------------------------
> Give me the changes in each of the three financial
> statements when accrued liabilities increases by
> $10 and the tax rate is 40%.
>
> IS- Expenses go up by 10, decreases EBIT by 10,
> gives a tax savings of 4 dollars but NI decreases
> by 6

Assuming that the question is asking what happens if expenses go up by $10 and rather than being paid in cash they are accrued, this is correct. Same effect as with depreciation - ten m ore dollars of expense is 10 more dollars of expense

> BS- Liabilities increase by 10 and SE decreases by
> 6, Assets increase by 4 (A=L+SE 4=10+(-6))

Accrued liabilities up by $10
Equity down by $6
but..... what is the SPECIFIC asset that increases to balance this out?

The answer is, in all likelihood your income statement tax savings translate into a lower accounts payable, ie taxes payable down by $4.
L= +$10-$4=$6 and equity =-$6

An accrual (manual adjustment for liabilities by the company at yer end or proforma by the analyst to restate financials) will not put immediate cash in hand from lower taxes on the balance sheeet date.


> CF- CFO goes up because of net increase of $4 in
> cash

As stated above no cash and no cash flow effect.

Re the question in the next post, using the indirect method you start with NI and adjust for chnages in working capital accounts. This lower net income will wash agianst the net changes in the liabilities discussed above.
 
> > BS- Liabilities increase by 10 and SE decreases
> by
> > 6, Assets increase by 4 (A=L+SE 4=10+(-6))
>
> Accrued liabilities up by $10
> Equity down by $6
> but..... what is the SPECIFIC asset that increases
> to balance this out?
>
> The answer is, in all likelihood your income
> statement tax savings translate into a lower
> accounts payable, ie taxes payable down by $4.
> L= +$10-$4=$6 and equity =-$6
>
> An accrual (manual adjustment for liabilities by
> the company at yer end or proforma by the analyst
> to restate financials) will not put immediate cash
> in hand from lower taxes on the balance sheeet
> date.
>
>
> > CF- CFO goes up because of net increase of $4
> in
> > cash
>
> As stated above no cash and no cash flow effect.
>

thanks. this part was very helpful.
 
company buys a building for $10M with cash.
straight line depreciation over ten years.
tax rate= 40%

how do i do this one?
 
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