LIFO increases CFO because the higher expenses result in a lower taxable income and therefore more cash. Depreciation methods do not affect cash flows, but don’t they essentially have the same effect, i.e., they manipulate earnings which results in a differing tax bill and therefore cash savings as well. Nay or yay?
normally yes just that as far as I know from tax point of view you have to use a specific depreciation method
What I don’t understand though is this: If LIFO increases cash flows vis-a-vis FIFO, why does choice of depreciation method have no effect on cash flows? They are both in effect expense items that can be manipulated on the income statement, yet only one has an effect on cash flows???
It is my understanding that for book purposes, your depreciation method does affect earnings. Obviously this won’t affect cash-flow. However for tax purposes, I believe there a more standardized method is applied. It is called MACRS. Think it stands for Modified Accelerated Cost Recovery System… anyhow, that’s not important. But what I am getting at is: The depreciation method used for calculating book income will not affect your tax cash-flow. Does this make sense to others out there?
I’m still having trouble grasping it. I know from readings that depreciation does NOT affect cash flows, and I accept it, but I want to understand why not…suppose double declining method is chosen over SL method…then reported income is lower in the earlier years and therefore less taxes would be paid and more cash in pocket? Basically, I don’t get why a firm saves cash when they use LIFO over FIFO, but they don’t save cash when using double-declining over SL…know what I mean?
When a firm uses LIFO on the fin stmts they have to use lifo for tax purposes. Hence the choice of inventory methods does affect cash flow. The choice of depreciation methods used in the fin stmts does not affect cash flow since you are not bound to use the same method for tax purposes. Many companies use straight line in fin stmts and accelerated methods for tax.
apcarlso is absolutely right. depreciation method used in financial statements has nothing to do with depreciation method used for tax purposes. as a result depreciation method used in financial statements (we work with those in FSA) doesn’t affect cash flows. Difference of depreciation methods used in financial statement and tax statements is one of the sources of deferred tax liability.
depreciation does not affect cash flows except for tax paid if it is allowed to use more than one method of depreciation all the examples in the book do not take into account the tax influence on cash flows