An asset is written down due to impairment. In subsequent accounting periods, the effects on the firm’s financial statements will include: a. Lower pretax cash flow. b. Higher profitability. c. Higher depreciation expense. d. Higher shareholders’ equity. Dreary
Probably B. As assets goes down, ROA goes up, which is a profitability ratio - Dinesh S
B? Similare reasoning as Dinesh’s
Why not D?
Why not C? If the asset is worth less than previous estimates, wouldn’t that count as additional depreciation?
Shouldn’t be C, …correct me if iam wrong…asset impairment is a direct charge to equity. i.e. if we impair the asset down by $100, equity is reduced by $100. (or maybe its after tax impact). Now the book value of the asset has decreased by $100, assuming no change to depreciation method, subsequent depreciation will be less. If the above reasoning is correct, which I think it is…it should rule out D as well. Answer is B simmilar reason as Dinesh + as future depreciation expense goes down, NI should increase.
With regards to D, if future profitability increases (answer B), then doesn’t shareholder’s equity increase? Remember, we are talking about subsequent periods, not the current period. Dreary
dinesh.sundrani Wrote: ------------------------------------------------------- > Probably B. As assets goes down, ROA goes up, > which is a profitability ratio > > - Dinesh S Dinesh, assets go down but don’t forget that NI also goes down and considering that the numerator effect will dominate, profiability goes down as well, but that’s in the year that the asset is impaired. In subsequent years (which is what the question is asking), profitability will go up, because NI will be higher (less depreciation). So, I’m betting on B. The other ones are not right, because: a) impairment doesn’t affect cash flows c) deprciation is lower in subsequent years (since assets are now lower) d) I’m a bit shaky on this one, but equity decreases in the year of the impairment, and I’m not sure if it has any impact in subsequent periods. I’d guess not. I’d say B.
This is a crappy question. B is correct for all the reasons above. D is correct because future period income will be higher (lower dep. expense and no future impairment)
I don’t buy D. Shareholder equity will be reduced by the entire impairment amount. Whereas in subsequent periods, NI will increase only by the amount of per period depreciation reduction. so, if an asset has 5 years of economic life initial value is 1,000 initial depreciation = 200 (SL) Tax rate = 40% If it is impared by 100, equity will decrease by 100 right away. whereas future depreciation expense will reduced only to (1000-100)/5 = 180 i.e 20 increase in EBIT per period. After tax increase = 0.60 * 20 = 12 It will take 8+ periods for equity to reach the initial level. on the other hand, the assets are lower right away and NI will be higher, thus profitability will increase.
Yes, it is B. I like delhirocks reasoning better than the reason given below: Choice “d” is incorrect. Shareholders’ equity will be reduced by the difference between the amount by which the asset’s book value is reduced on the balance sheet and the related change in the net deferred tax asset/liability. Dreary