I got confused while solving this questions. Why in the statement 2 we adjust the operating profit for non-cash deprecation but in the statement 3 I can not choose the third option at the explanation says that “impaitment loss is a none cash item that does not affect operating cash flow”.
Here are these questions:
With respect to Statement 2, what would be the most likely effect in 2010 if AMRC were to switch to an accelerated depreciation method for both financial and tax reporting?
Net profit margin would increase.
Total asset turnover would decrease.
Cash flow from operating activities would increase.
With respect to Statement 3, what is the most likely effect of the impairment loss?
Net income in years prior to 2009 was likely understated.
Net profit margins in years after 2009 will likely exceed the 2009 net profit margin.
Cash flow from operating activities in 2009 was likely lower due to the impairment loss
It will be helpful if you could paste the actual statement the question is related to.
Impairment loss is a charge against goodwill (same as depreciation) and as no cash is exchanged with this entry it will not impact the operating cashflow for 2009. So impairment loss won’t lower the cashflow for 2009.
As to the correct answer, assuming impairment loss is a one time item on p&l unlike depreciation, the net profit will be higher for years after 2009 as there won’t be any impairment loss following year.
My confusion is why we can adjust the depreciation to operating cash flow (indirect method) even though the depreciation is a non-cash item whereas we can not adjust the impairment loss to operating cash flow (indirect method) .
The statements themselves are as follows:
Statement 2.“AMRC uses the straight-line method of depreciation for both financial and tax reporting purposes to account for plant and equipment.”
Statement 3. “In 2009, AMRC recognized an impairment loss of €50 million on a fleet of locomotives. The impairment loss was reported as ‘other income’ in the income statement and reduced the carrying amount of the assets on the balance sheet.”
You adjust all non-cash items, both depreciation and impairment. After all, the goal is to reach the cash flow from operations, and this won’t happen if you still have an impairment lingering there unadjusted.
I think you may be confused by the statements. Just because the impairment affected the P&L/BS already, doesn’t mean it won’t affect the cash flow statement.
Basically the accounting entries are as follows:
Dr Other Income (impairment loss effect in P&L);
Cr Accumulated impairment loss (in the BS);
Since your net income (which you start adjusting to reach cash flow from operations) is now affected by a non-cash expense, you need to add it back.