[question removed by admin] Why does the textbook say the answer is C? If you’re writing down the value of equipment as it gets old, isn’t this depreciation and isn’t depreciation expense an OPERATING cash flow item?
Where’s the cash flow when you write-off obsolete equipment (or anything else, for that matter)?
I guess now that you ask, it sounds like depreciation is something that shows up on the income statement but not the cash flow statement?
The book appears to give conflicting comments about this. On one hand, they list depreciation as a cashflow item but then it specifically states that depreciation expense is not a cashflow item. I’m really confused.
I think I know where you are coming from. Depreciation is a non-cash expense which need to be accounted for when you are computing CFO using indirect method.
Consider the below simplified P&L statement:
Revenue: XXXX
Less Expense: (X)
EBIT: XXX
Less Interest: (X)
Less Tax: (X)
Net Income: X
When you are using the indirect method , we start from Net Income and do the following:
Net Income
Add Depreciation/Amortization
Add Loss from disposal/ Less Gain from disposal *unless the disposal is pertaining to operating activities*
Add/Less Changes in balance sheet accounts
They list it as cashflow- in a way that they are telling you that they need to be adjusted back as they are non-cash; not telling you to treat them as cashflow.
Depreciation is not a cash flow. The cash flow comes when you pay for the asset, not when you depreciate it.
While it is true that Depreciation expense occurs in the operating section of the CF statement, it does not represent a cash outflow - it’s merely the allocation of a prior expense. The reason it is added back in the calculation of CFO is that you start from NI, which has been decreased (relative to cash accounting) by the depreciation amount.
The actual impact of $100 of additional depreciation on a firm’s cash flows would be (assuming a 20% marginal tax rate) would be $20 (the Depreciation expense lowers taxable income by $100 without a concurrent outflow of cash). This decreases tax liability by $20.
This effect is sometimes called the “tax shield from depreciation.”
http://www.marketwatch.com/investing/stock/twtr/financials/cash-flow
This is Twitter’s (negative) cash flow. It must be a really poor investment now lol
So you see how depreciation is listed under Operation Cash Flow? Is this an example of direct or indirect calculations?
It starts with net income, so it’s . . . ?
Okay I think it’s an example of “indirect” method, but doesn’t GAAP require that companies report with the direct method?
Or do companies release 2 different copies of financial statements - one using direct and one using non-direct
US GAAP encourages companies to use the direct method, but doesn’t require it. The SEC requires the indirect method.
Which one do you think most companies in the US use?
Thanks for the clarification, I see that now in the textbook