From an answer in CFAI:
“The impairment loss is a non-cash charge and will not affect cash flow from operating activiites”
But doesn’t an impairment charge bring down net income, which in turn reduces tax expense and therefore increases cash flow from operating activities?
Impairment losses are generally not deductable for tax purposes; tax authorities generally require a taxable event (i.e., a sale) before the loss can be recognized.
This is similar to the treatment of unrealized gains/losses on investments in securities that are marked to market annually: the unrealized gain or loss doesn’t have any effect on taxes.
All of this junk creates DTAs and DTLs (remember those from Level I?) on the balance sheet.
^This
Another way to think of impairment is just an additional accounting amortization charge, which we know is not deductible for tax purposes (tax amortization calculated separately, results in DTL or DTA).
I came on to ask this exact question. It’s confusing because clearly impairment and and a change in depreciation will change operating income on the income statement. The tax amount shown on I/S will clearly change as well. The confusion comes in when that doesn’t actually reflect their tax payment because of DTL and DTA. Still a pretty confused there.
I took a one year break after Level 1… so I extra don’t remember.
Could you elaborate a bit on what in particular you’re having difficulty understanding? I’ll try to explain
For instance. Impairement or a change that causes an increase in depreciation for a given period… it will cause earnings to decrease and then the amount on I/S that will be calculated for taxes would be lower. This would cause NI to be lower and then retained earnings would be lower as well. First of all, how does operating CF not get impacted by this situation?
I think I know partly where you’re getting confused.
Tax net income and accounting net income are not the same. Taxes tend to be calculated based on net income that is closer to being cash basis, where accounting net income is on an accrual basis. Assets from an accounting perspective are depreciated based on management’s best estimate of useful life, while amortization from a tax perspective is based on what asset class something is, as defined by the IRA (CRA in Canada) - which may amortize faster/slower than management’s accounting amortization. Thus, taxable net income is almost always different from the net income you see on the income statement.
Because impairment is a non-cash charge, it both a) is added back in determining CFO, therefore having no net impact on cash flows, and b) doesn’t affect taxes payable because it’s not an eligible deduction for tax puposes. It would decrease tax expense because the DTA/DTL would be debited (i.e. if an asset, would increase, and if a liability would decrease).