I just got a quick question thats probably simple… So I know depreciation is a non-cash expense that doesn’t affect cash flows…but why not? If you choose double-declining vs. straight-line…dep expense goes up, which leads to lower EBIT in the early years and because of that wouldn’t your taxes paid be lower? So those would be savings/less taxes paid and in turn increase cash flow from operations? Lets hear it…what am I missing? Thanks for the help!
Different depreciation methods can be used for financial reporting and tax reporting. Tax expense shown on the income statement is typically different from actual taxes paid on the tax return. For tax reporting, I believe MACRS is used, which is an accelerated depreciation method. For financial reporting, companies typically use straight line but sometimes use other methods. When tax expense and taxes paid are different, the company will record either a deferred tax asset or deferred tax liability. Typically deferred tax liabilities are recorded in relation to depreciation differences because the company expects to actually pay more in taxes later than what is reported on the income statement (taxes paid > tax expense). You’ll learn all about this once you get to this section in the readings.
Amtrak Wrote: ------------------------------------------------------- > I just got a quick question thats probably > simple… > > So I know depreciation is a non-cash expense that > doesn’t affect cash flows…but why not? If you > choose double-declining vs. straight-line…dep > expense goes up, which leads to lower EBIT in the > early years and because of that wouldn’t your > taxes paid be lower? So those would be > savings/less taxes paid and in turn increase cash > flow from operations? Lets hear it…what am I > missing? > > Thanks for the help! you are right, there is an effect to cash flow under the more aggressive depreciation methologies. That’s the reason its used in the first place, that and the fact that you could deffered the taxes to the future.
Derpreciation is used by companies because it gives them a tax shield - in calculating the Cash Flow these taxes payable and deferred taxes are included. cash taxes = -tax expense + inc in taxespayable + inc in deferred taxes
Amtrak - you are correct in that depreciation does have an effect on cash - indirectly through taxes. The “depreciation expense” BY ITSELF has no effect on the flow of cash. Depreciation expense only affects cash indirectly and this indirect effect is completely accounted for by tax expense of one form or another. Try this: A company operates in a jurisdiction with no taxes. In this extreme case the company still incurs depreciation expense. The depreciation also still reduces EBIT. But where is the effect on cash flow?.. there is none. In this case depreciation expense does not even indirectly affect the flow of cash no matter how large it is. Did I get all my affect/effect usage correct?
Amtrak, epoh, and mkgref: -1 TMurf: +1 I don’t believe companies have a choice of depreciation for tax purposes: it has to be macrs. Thus cash flow is insensitive to choice of method for financial reporting purposes.
Depreciation is a non-cash expense that affects cash flows. That should be accounted for when comparing two companies that use different depreciation methods.
“The Modified Accelerated Cost Recovery System (MACRS) is the current method of accelerated asset depreciation required by the United States income tax code.” More at http://en.wikipedia.org/wiki/Macrs. So, final answer: choice of depreciation method (for financial reporting, which does not determine taxes payable) has no impact on cash flows.
Good summary, DarienHacker!
Thank you all for your input! AF Rules!!