# FSA qbank question

Schweser qbank # 87558 The question is about a change in depreciation assumptions. Originally, the company purchased \$140M of eqpt and depreciated over 7 years with no salvage. At the end of year 1, they switch to 5 years with 10% (\$14M) salvage. They then ask you to calculate the change in ROA. Original Financials: Depreciation expense \$30 million Net income \$30 million Total assets \$535 million Shareholder’s equity \$150 million Effective tax rate 35 percent So, original ROA and ROE are 5.6% (30/535) and 20% (30/150) Schweser’s new financials: Depreciation expense \$35.2M (30 + 5.2) Net income \$26.2 (30 - (5.2*0.65)) Total assets \$529.8 (535 - 5.2) Shareholder’s equity \$144.8 (150 - 3.38 - 1.82) Effective tax rate 35 percent So, i get how to adjust NI properly. What I’m confused about are the BS adjustments. The way I’m thinking of it, PPE decreases by the 5.2 change in depreciation, then cash increases 1.82 (5.2 * 0.35) due to the tax savings from increased depreciation. So total assets would decrease by 3.38, not the full 5.2. Then that 3.38 would flow through to equity, which would tie to the change in RI. Can someone help me on this? Schweser has a couple of these questions in the qbank, and I keep getting them wrong.

From an adjustment perspective instead of thinking of the 1.82 as an increase in cash … due to tax savings would be wrong… the tax has already been paid in the previous year. and you are not going to get the cash once paid back from the IRS… Instead I think the right way to look at it is: Assets reduce 5.2 due to change in accumulated depreciation. Shareholders equity thro’ the NI route reduces 3.38 Now there is a 1.82 difference - which would be a straight adjustment to equity. A = L + E A down 5.2, E down 3.38 due to net income… diff of 1.82 - would be an E reduction.

cpk123 Wrote: ------------------------------------------------------- you are not going to get the cash once > paid back from the IRS… ahh that’s where i got tripped up. i knew cpk would be the first to respond. do you ever sleep?

The 1.82 will be the deferred tax liability because it’s the increase of tax expense but there is no increase in tax payable. Noramlly CFAI put the DTA into the equity category.

DTA would be a reduction of equity… DTL if it is not going to reverse (reduce) would be an increase of equity…

I believe it’s a deferred tax asset or reduction in deferred tax liability. You already paid tax on lower depreciation, so now after adjustment you’ve paid the “same” tax on higher depreciation (lower tax expense). tax expense (lower) = taxes payable (the same) + DTL - DTA (DTL - DTA) has to be smaller.

16.15 is the tax you paid to the government under 30 mill net income 14.34 is the tax you “should” have paid to the government under 26.62 mill net income You paid more tax after the adjustment than you should have, that’s a DTA

I was talking purely in terms of a adjustment to equity… Agree it would be a DTA. and since you would immediately reduce that and then adjust equity – it would be reduction of 1.82 to equity. I was responding to Blackdog’s statement above: “The 1.82 will be the deferred tax liability because it’s the increase of tax expense but there is no increase in tax payable. Noramlly CFAI put the DTA into the equity category.” to clarify… both DTA and DTL are adjusted thro’ equity when the amount is not expected to reverse… DTA adjustment would be a reduction to equity, DTL adjustment would be an increase in equity. and from the point of view of this problem - there was no need to go thro’ the two step process of first trying to understand whether the amount went to DTL or DTA or whether the adjustment directly happened on equity…

Yes, sorry CP, I should have mentioned I was agreeing with you, but disagreeing with BlackDog as well.

ali… no need to be sorry. I am learning just as you are… I should have clarified above, just like I did in response to your comment.